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OUTLINES OF ECONOMICS 



THE MACMILLAN COMPANY 

NEW YORK • BOSTON - CHICAGO • DALLAS 
ATLANTA • SAN FRANCISCO 

MACMILLAN & CO., Limited 

LONDON • BOMBAY • CALCUTTA 
MELBOURNE 

THE MACMILLAN CO. OF CANADA, Ltd. 

TORONTO 



OUTLINES OF ECONOMICS 



(THIRD REVISED EDITION) 



BY 
RICHARD T. ELY 

PROFESSOR OF POLITICAL ECONOMY IN THE UNIVERSITY OF WISCONSIN 



THOMAS S. ADAMS 

PROFESSOR OF POLITICAL ECONOMY IN THE SHEFFIELD SCIENTIFIC 
SCHOOL OF YALE UNIVERSITY 

MAX O. LORENZ 

ASSOCIATE STATISTICIAN, INTERSTATE COMMERCE COMMISSION 

ALLYN A. YOUNG 

PROFESSOR OF ECONOMICS AND FINANCE IN 
CORNELL UNIVERSITY 



THE MACMILLAN COMPANY 
1916 

A^i rights reserved 



vre 



|7l 

■ Es-f 



Copyright, 1893, 
By hunt & EATON. 

Copyright, 1908, and 1916, / 

By the MACMILLAN COMPANY. 



First published elsewhere. Reprinted May, 1900; July, October, 
1901 ; August, 1903; July, September, 1904; July, 1905; January. 
August, 1906; July, 1907; April, 1908. 

New edition, revised and enlarged, September, 1908. 

Third edition, revised and enlarged, September, 1916. 




SEP 30 1916 



NotfajootJ J^ress 

J. S. Cushins Co. — Berwick & Smith Co, 

Norwood, Mass., U.S.A. 



'ci.A4:n9ooc;/r" 



PREFACE 

The first edition of the Outlines of Economics, written by 
Professor Ely, was published in 1893. Four persons cooperated 
in the preparation of a revised and enlarged edition, which 
appeared in 1908. This was in many respects a new book, 
although much matter from the earlier edition was incorpo- 
rated in it, and although pains were taken to retain the general 
organization and especially the general point of view of the 
older volume. The present edition does not differ so much 
from its predecessor as that differed from the first edition, but 
it is, nevertheless, the result of a more thoroughgoing revision 
than is usually given to books of this kind. 

Some minor changes have been made in the order in which 
the chapters appear ; two chapters have been omitted ; and 
a chapter on labor legislation has been added. No chapter 
in the book remains unaltered, and the larger part of Books II 
and III has been virtually rewritten. While the number of 
different subjects treated has been slightly reduced, the treat- 
ment of the more fundamental subjects has been considerably 
expanded. Each of us has undertaken the revision of a definite 
portion of the book and, to secure unity, Professor Young has 
had general editorial supervision of the revision as a whole. 

Some of the changes are such as are necessary by reason of 
eight years of progress in industrial life, in legislation, and in 
economic thought. Other changes are the outgrowth of the 
experience gained in eight years' use of the book in university 
and college courses. Among the many persons to whom we 
are indebted for helpful criticisms and suggestions are Dr. John 
Cummings, Professor H. J. Davenport, Dr. C. S. Duncan, 
Professor L. C. Gray, Professor J. E. Le Rossignol, Professor 



VI PREFACE 

W. C. Mitchell, Professor T. W. Page, Professor F. M. Taylor, 
Mr. Ray S. Trent, and Professor N. A. Weston. 

The instructors in charge of the course in elementary eco- 
nomics at the University of Wisconsin have generously cooperated 
by submitting carefully prepared lists of definite, well-con- 
sidered, and pointed suggestions for the betterment of the 
book. We make grateful acknowledgment to Professors T. K. 
Urdahl, W. I. King, and H. D. Simpson, and to Messrs. Harry 
Jerome, A. H. Hansen, J. G. McKay, and F. L. Vaughan. 

THE AUTHORS. 
September, 1916. 



Preface 



CONTENTS 
BOOK I. — INTRODUCTION 

Chapter I. — The Nature and Scope or Economics 



Diversity of economic study, 3 ; Definition of economics, 4 ; A 
social science, 5 ; Studies man in process of development, 6 ; Eco- 
nomic laws, 7 ; Relation of economics to other sciences, 1 1 ; Prin- 
cipal divisions of economics, 15. 

Chapter II. — The Characteristics of the Present Economic System 

Human and physical conditions of economic activity, 1 7 ; Private 
enterprise and state activity, 17 ; Division of labor and exchange, 
19 ; Economic classes, 21 ; Private property, 21 ; Trade-marks, copy- 
rights, and patents, 23 ; Inheritance, 24 ; Contract, 25 ; Vested in- 
terests, 25 ; Freedom, 26 ; Competition and markets, 28 ; Fair 
competition, 29; Cooperation, 30; Monopoly, 30; Custom, 31. 

Chapter III. — The Evolution of Economic Society 

Basis of the economic stages, 33; Direct appropriation, 34; 
Primitive man, 35; Pastoral stage, 36; Agricultural stage, 37; 
Manorial economy in England, 37; Handicraft stage, 39; Gilds, 
39; Domestic system, 40 ; Agricultural changes, 41 ; The mercan- 
tile system, 42 ; Industrial stage, 44 ; Other classifications, 44. 

v^l Chapter IV. — The Evolution of Economic Society {Continued) 

Industrial Revolution, 47 ; England in 1760, 47 ; Mechanical in- 
ventions, 49 ; Agricultural changes, 50 ; Effects of industrial revolu- 
tion, 51; The factory system, 51; Industrial specialization, 2; 
Evils of the transition, 52 ; Competition and laissez-faire, 53 ; Re- 
action against the passive policy, 54; Quality of goods, 55; Pro- 
tection of labor, 55 ; Labor organizations, 57 ; E.xtension of govern- 
ment enterprise, 58 ; Summary, 59. 



/P 



-v 



Vlll CONTENTS 

Chapter V. — The Economic Development of the United States 
Economic stages in American industrial history, 6i; Sectional- 
ism, 62; Characteristics of the American people, 63; Growth of 
population, 64 ; Slavery and the negro problem, 66 ; Immigration, 
68;- Natural resources, 74; Public lands, 75. 

Chapter VI. — The Economic Development of the United States 

{Continued) 

Mercantilism in America, 79 ; English colonial policy, 80 ; 
American industries in 1776, 81; The Industrial Revolution in 
America, 81 ; The development of agriculture, 84; Manufactures, 
86 ; Transportation, 90 ; The labor movement, 93 ; State regula- 
tion of industry, 96. 

BOOK II. — PRINCIPLES AND PROBLEMS 
PART I. — PRODUCTION AND CONSUMPTION: 

Chapter VII. — Elementary Concepts 

Motives in economic activity, 103 ; Utility, 105 ; Free and eco- 
nomic goods, 105 ; Effort and waiting, 106 ; Risk, 106 ; Personal 
quahties as goods, 107 ; Wealth and income, 108 ; Individual and 
society, 109 ; Wealth and value, 109 ; Capital and other forms of 
wealth, no; Capital goods and capital value, no; Social and in- 
dividual capital, in ; National wealth and national dividend, in. 

Chapter VIII. — Production 

Production defined, 116; Production of values, 118; Factors of 
production, 119; Saving and capital formation, 122; Production 
and sacrifice, 124; Organization of productive factors, 123; The 
entrepreneur, 1 23 ; Division of labor, 124; Advantages of division 
of labor, 126 ; Effects upon the worker, 127 ; Territorial division of 
■ labor, 128; Productive organization of the American people, 129. 

Chapter IX. — Consumption 

Consumption defined, 132; Productive and final consumption, 
132; Human wants, 133; Law of diminishing utility, 133; Mar- 
ginal utility, 135 ; Subjective value, 137 ; Economic order of con- 
sumption, 139 ; Future wants, 140 ; Consumption and saving, 142 ; 
Alleged present consumption of future products, 142 ; Luxury, 143 ; 
Harmful consumption, 144; Statistics of consumption, 144; Pro- 
duction and sacrifice, 146 ; Cost of production, expense of produc- 
tion, and opportunity cost, 148. 



-f 



CONTENTS ix 

/ PART II. — VALUE AND EXCHANGE 

Chapter X. — Value and Price 

Meaning and significance of value, 151 ; The market, 153 ; Ex- 
change value and subjective value, 155 ; Supply and demand, 156 ; 
Nature of demand, 156; Elasticity of demand, 159; Nature of 
supply, 162; The determination of price, 164. 

Chapter XL — Value and Price {Continued) 

Prices and the expenses of production, 167; Normal price, 169; 
Different conditions of supply, 170; Fixed. and variable expenses, 
174 ; Joint expenses of production, 179 ; Surplus of bargaining, 181 ; 
Non-reproducible goods, 182 ; Retail prices, 182 ; Public authority 
and value, 183; Imputed value, 184; Valuation of production 
goods, 185; Other theories of value, 186. 

Chapter XII. — Monopoly 

The idea of monopoly, 189; Classification and causes, 193; 
Social and natural, 195 ; Monopoly price, 200 ; Effect of a tax, 202 ; 
Relation of demand to monopoly price, 203; Class price, 204; 
Monopoly price, high price, 205 ; Monopolies and distribution of 
wealth, 207 ; Public policy toward monopolies, 208. 

Chapter XIII. — Business Organization 

The meaning of "business," 212 ; The nature of business units, 
212; The business unit in accounting, 213; The individual entre- 
preneur, 214; Partnerships, 215; The business corporation, 216; 
The corporation charter, 217; Lack of uniformity in state laws, 
218; Corporation capital and capitalization, 219; Overcapitaliza- 
tion, 221 ;^ Form of capitalization, 225 ; Corporation management, 
226; Advantages of the corporation, 228; Social aspects of cor- 
porations, 228; Trusts, 230; Causes of combination, 232; Anti- 
trust laws, 235 ; Unfair competition, 239 ; Public policy towards 
industrial combinations, 243 ; Federal control of Corporations, 
245 ; Industrial combinations in other countries, 245. 

Chapter XIV. — Money 

Metallic money, 248; Coinage, 249; The meaning of "money," 
250; The media of exchange, 252; The monetary standard, 255; 
Seigniorage, 255; Limited coinage, 259; BimetalHsm, 260; Bi- 
metallism in the United States, 263 ; The gold-exchange standard, 
269; Government paper money, 271 ; Colonial and Revolutionary 
bills of credit, 273; The greenbacks, 273; Fiat money, 278. 



Xj 



-p- 



f: 



CONTENTS 

Chapter XV. — Credit and Banking 

Credit transactions, 282 ; Personal credit, 285 ; Bank credit, 
286 ; Bank notes, 290 ; State banks of issue, 290 ; National bank- 
ing system, 291; The reserv^e system, 292; New York money 
market, 293 ; Speculation, 295 ; Independent treasury system, 
297 ; The movement of money, 298 ; Inelastic currency, 300 ; In- 
elastic reserves, 301 ; Absence of centralized control, 303 ; Steps 
toward reform, 304 ; Federal reserve system, 307 ; State and private 
banks, 313. 

Chapter XVI. — Other Problems in Money and Banking 

The value of money, 317; Quantity of money and the values of 
money, 319; Equation of exchange, 321; Mechanism of general 
changes in prices, 325; Industrial uses of gold, 327; Expenses of 
gold production, 328; Increase in gold production, 329; Effects of 
changes in prices, 331; Crises, t,;^,^; Standard of deferred pay- 
ments, 336; Index numbers, 337. 

Chapter XVII. — International Trade 

Foreign exchange, 345; Regulation of the gold supply, 350; 
Balance of trade, 354; Restriction of international trade, 35S; 
Advantages of international trade, 361. 

Chapter XVIII. — Protection and Free Trade 

The case for protection, 368; Arguments of free-traders, 374; 
General considerations, 380; Conclusions, 381. 



yr^ 



PART III. — DISTRIBUTION 

Chapter XIX. — Distribution as an Economic Problem 



0i 



The problem of distribution, 384; Distribution controlled by 
existing institutions, 386 ; Money incomes, 387 ; Law of diminish- 
ing productivity, 388 ; Marginal product of labor, 390 ; Marginal 
products of land and capital, 392 ; Marginal productivity and the 
prices of production goods, 398; The meaning of "productivity," 
400; Social aspects of diminishing productivity, 404. 

Chapter XX. — The Rent of L.and 

Rent defined, 407 ; The services of land, 408 ; Rent under uni- 
form intensivity of cultivation, 410 ; Rent under actual conditions, 
413; The different uses of land, 416; The capitalization of rent, 
418; Rent and social progress, 419; The unearned increment, 
422; Urban lands, 426. 



CONTENTS XI 

Chapter XXI. — The Wages of Labor 

Wages as the price of labor, 427 ; Demand for labor, 428 ; Labor- 
saving machinery, 430; Supply of labor, 431 ; Growth of popula- 
tion, 434; Subsistence theory of wages, 437 ; The standard of life 
and wages, 438 ; Supply of labor in different occupations, 439 ; The 
wage contract, 442. 

Chapter XXII. — Labor Problems 

Tjrpes of labor organizations, 444 ; Economic justification of 
labor organizations, 445 ; Labor organizations and monopoly, 446 ; 
Methods and policies of labor organizations, 447 ; The closed shop, 
448 ; Limitation of output, 449 ; Educational and fraternal activi- 
ties, 451; The strike, 452; Employers' associations, 454; Trade 
arbitration, 457 ; Voluntary arbitration, 458 ; Compulsory arbitra- 
tion, 459; Profit sharing, 461; Industrial democracy, 463; Co- 
operation, 465 ; The future of the union, 469. 

Chapter XXIII. — Labor Legislation 

Freedom of contract, conspiracy, and injunctions, 472 ; Child 
labor laws, 476 ; The labor of women, 479 ; Minimum wage laws, 
480 ; Factory acts, 484 ; Employers' liability, 486 ; Philosophy of 
labor legislation, 488. 

Chapter XXIV. — Interest 

Interest defined, 493 ; Inadequate explanations, 494 ; How in- 
terest is possible, 495 ; Why interest is necessary, 496 ; Invest- 
ment, 499 ; Replacement, 501 ; Shifting of investment, 502 ; 
Expense and price of capital, 504; Free and specialized capital, 
506 ; Capital and land, 507 ; Capital and consumption goods, 512 ; 
Capital and wages, 512; Competitive investment, 513; The 
flow of money income, 515; The annual product and the social 
dividend, 517 ; Sourcesof investment funds, 523 ; The interest rate, 
521 ; Gross and net interest, 523 ; Usury laws, 524. 

A^*>g» Chapter XXV. — Profits 

Profits a surplus, 525; Entrepreneur's wage, 526; Pure profits 
impossible under certain conditions, 527; Sources of pure profits, 
528; Marginal productivity and profits, 532; Profits for the in- 
dustry and profits for the establishment, 533 ; Good-will, 535 ; 
The relation of risks to profits, 536 ; The entrepreneur, 537 ; Profits 
and the defense of the competitive system, 538. 



Xll CONTENTS 

Chapter XXVI. — The Personal Distribution of Wealth 

Wealth and income, 542 ; Absolute and relative well-being, 542 ; 
Concentration of wealth and large-scale production, 542 ; Methods 
of measuring concentration, 543; Statistics of distribution, 544; 
Causes of poverty and riches, 549; Is greater diffusion possible? 
551 ; Modifying the methods of wealth acquisition, 553. 

Chapter XXVII. — Transportation Economics 

Scope and significance, 557; Nature of the railway industry, 
558; Railway competition, 560; Pooling and consolidation, 561; 
•The movement of rates, 563 ; The level of rates, 565 ; Relative 
rates, 567; Distance, 570; Government ownership, 571 ; Regula- 
tion, 573 ; The Interstate Commerce Commission, 574. 

Chapter XXVIII. — Insurance 

Nature of insurance, 577 ; Origin and development, 578; Forms 
of insurance organization, 580; Life tables, 581; Reserve, 583; 
Surplus, 583; Endowments, 584 ; Industrial insurance, 585 ; State 
insurance, 585 ; State regulation, 586 ; Social insurance, 587 ; 
Workmen's compensation, 588; Sickness insurance, 591; Old-age 
insurance, 592 ; Unemployment insurance, 592 ; Objections to 
social insurance, 593. 

Chapter XXIX. — Agmcultural Problems 

Size of farms, 596 ; Ownership and tenancy, 603 ; Farm labor, 
606 ; Farm indebtedness and agricultural credit, 609 ; Tenancy vs. 
encumbered ownership, 615; Marketing of farm products. 618; 
Speculation, 622. 

Chapter XXX. — Socialism 

Socialism defined, 627; Distributive justice, 627; Varieties of 
socialism, 628; Communism, 631; Socialism an extension of 
existing institutions, 632; The strength of socialism, 632; The 
weakness of sociahsm, 634 ; The sociahst movement, 636 ; Anar- 
chism, 638. 



BOOK III. —PUBLIC FINANCE 
Chapter XXXI. — Public Expenditures 

Nature and significance of public finance, 643 ; Public and pri- 
vate expenditures contrasted, 646 ; The proper proportion between 
the total income of society and pubhc expenditures, 648 ; Economy 



CONTENTS Xlll 

vs. parsimony, 652; Historical development, 654; Development 
of public expenditures with respect to regularity and irregularity, 
659 ; Classification of public expenditures, 660. 

Chapter XXXII. — Public Revenues from Loans and Government 

Ownership 



nnf 



Public debts, 666 ; Public domains, 671 ; Land policy of the 
United States, 673 ; Forest lands, 674; Mineral lands, 675 ; Success 
of our land policy, 677 ; Land nationalization and municipalization, 
679; Public industries, 682. 

Chapter XXXIII. — Public Revenues : Derivative Revenues, Fees, 
Special Assessments, and Taxes 

Definitions, 689 ; Fees, 690; Special assessments, 692; Taxes, 
694 ; Justice in taxation, 696 ; Progressive taxation, 699 ; Direct 
and indirect taxes, 702 ; The shifting of taxes, 703. 

Chapter XXXIV. — Public Revenues : Federal, State, and Local 
.^^ Taxes 

n 

Constitutional limitations, 710 ; Use of direct taxes by the federal 
government, 712; Customs duties, 713; Internal revenue duties, 
717; Taxes on transactions, 719; Income taxes, 720; Inheritance 
taxes, 723; General property tax, 726; Corporation taxes, 731; 
Business and license taxes, 733; Poll taxes, 734; A balanced 
revenue system, 735. 

Appendix A : History of Economic Thought 741 

Appendix B : Suggestions for Students and Teachers . . . 754 
Index 761 



7/^ 



BOOK I 
INTRODUCTION 



OUTLINES OF ECONOMICS 

CHAPTER I 

THE NATURE AND SCOPE OF ECONOMICS 

The most striking characteristics of the great field of knowl- 
edge the Outlines of which we attempt to sketch in the present 
volume are its rich diversity and spacious amplitude. Start- 
ing from psychology in its analysis of the human needs which 
explain or condition wealth, it traverses the entire field of social 
activities and institutions arising from man's efforts to supply 
his material needs. It touches on one side the physical sciences, 
from which it borrows some of its most fundamental prin- 
ciples ; occupies joint territory at places with politics, ethics, 
and law, although their respective jurisdictions are in the main 
distinct ; and forms at once the most fertile and most thoroughly 
developed province of the broad science of human society. 
Within its borders, if we may continue to compare the scientific 
possibilities of economics with the natural resources of an opu- 
lent territory, opportunity is offered for the exercise of every 
mental aptitude and every scientific method. The historian's 
gift is needed to unravel the past and trace the development 
of the industrial institutions whose present-day problems, in 
turn, offer indefinite scope for the studies of the more practical 
student with a taste for administration or business manage- 
ment. For the legal mind there are the subtle problems of 
property, inheritance, labor legislation, and corporation con- 
trol ; for the mathematically inclined, insurance and modern 
statistics ; for students with practical political interests, the 
tariff, currency reform, and a score of important problems in 
which economics and politics are inextricably interwoven ; for 

3 



4 OUTLINES OF ECONOMICS 

the philanthropic, unemployment, accident insurance, and a 
number of social problems growing out of the maladjustments pi 
modern industry. Animating the entire subject, blended with 
the love of truth for truth's sake common to all sciences, is the 
persistent hope that by systematic study we may eventually 
abolish the material poverty which deadens and dwarfs the 
lives of millions of our fellows. Economics is a science, but 
something more than a science ; a science shot through with the 
infinite variety of human life, calling not only for systematic, 
ordered thinking, but for human sympathy, imagination, and 
in an unusual degree for the saving grace of common sense. 

To define such a subject adequately in a few sentences is 
manifestly impossible. It is frequently said that economics 
treats of man's efforts to earn a living, and this definition is 
not inaccurate if by " man " we understand " mankind," and 
if we fully appreciate that the individual's efforts to turn an 
honest penny's profit receive but little attention in comparison 
with the community's efforts to feed, clothe, and shelter itself. 
Satisfaction of social need, and not individual profit, is the 
objective point of the science. So, similarly, economics has 
been characterized as the philosophy of human industry ; and 
this description is illuminating provided we interpret " indus- 
try " broadly enough. Even the old traditional definition, that 
economics is the science of wealth, is true enough if we clearly 
understand that there can be no wealth without man, and that 
the science which deals with wealth, so far from being a " gospel 
of mammon," necessarily begins and ends in the study of man. 
As we prefer to define it, however, economics is the science which 
treats of those social phenomena that are due to the wealth-getting 
and wealth-using activities of man. 

Economics treats of Man. — The supreme importance of 
man in the study of wealth has not always been appreciated 
by those who have expounded the science. Too often they 
have considered man simply as a producer of wealth, the one 
" by whom " the necessaries, conveniences, and luxuries of 
life are created, whereas the infinitely greater truth is that man 
is the one " for whom " they are all produced. Of course no 



THE NATURE AND SCOPE OF ECONOMICS 5 

one denies this truth, but one might almost as well deny it as 
to leave it out of account. The result of such neglect is that 
men devise with great skill rules by which man may be made the 
best possible manufacturing machine. It sometimes quite 
escapes the notice of these persons that in making man the best 
possible manufacturing machine they may make him a very 
poor sort of a man ; that in teaching him to supply his wants 
very bountifully they may prevent his developing and correct- 
ing those same wants. They forget that there are two kinds 
of poverty — one a lack of goods for the higher wants, the other 
a lack of wants for the higher goods. To become rich in goods 
while losing at the same time the power to profit by them is 
unfortunately one of the commonest retrogressions in human 
experience. We do not mean that the whole problem of human [ 
development is the subject of economics, but simply that man- 
hood, rounded human development, and the equitable organiza- ^ 
tion of human relationships are the objects of all social sciences, 
and none must consider its subject so narrowly as to exclude 1 
these objects. 

Another common mistake has been to regard as of chief 
importance the economic activities of one particular dass^ 
especially the employer. Other men were treated simply as 
" a factor in production." An English writer speaks of dear 
labor as one of the chief obstacles to England's economic pros- 
perity. Could anything be more utterly an oversight of general 
human well-being? Dear labor should be the very goal of 
England's economic effort, for that means abundant supply 
of the wants of the great mass of her people ; and the fact that 
labor is dear, so far from being an obstacle to prosperity, is 
the very proof and substance of that prosperity. A glance at 
history indicates that men have made these mistakes not only 
in theory but in practice. Industries have been developed to 
majestic proportions while man was sinking into deeper deg- 
radation ; wealth has at times grown at the expense of that 
human weal in whose service it won its name. 

Economics treats of Man in Society. — This is one of those 
truisms which only history can make real to us. As we pass 



6 OUTLINES OF ECONOMICS 

from the savage and cannibal, up through all the stages of 
^ development, we find an ever-increasing interdependence 
among men. Man is least dependent when he wants least, 
cares least, has least, knows least, and is least. With every 
betterment of condition and character he is more dependent 
than before, more dependent and yet more free. The beginnings 
of barter are a confession of mutual need ; the coining of money 
is a declaration of dependence to all men. We look with pride 
upon a century of progress, but that progress has consisted in 
little else than a growth of dependence, an ever-increasing de- 
parture from that rude kind of literal self-help in which each 
one does everything for himself. Our fathers drew water, each 
for himself, in " the moss-covered bucket," while our mothers 
dipped candles for the evening's light. If one was negligent, 
the rest did not suffer. Today a network of pipes radiates from 
a common center to enter a thousand households. An engi- 
neer makes a blunder at the station, and thousands are in dark- 
ness or drought. Progress is a passage from independence to 
dependence, from distrust to confidence, from hostihty to amity, 
from helplessness to helpfulness, while the great law of social 
solidarity gains ever-increasing importance. Our science, then, 
is interested primarily in man in his relations to others, and 
not in man by himself. Moreover, as a science which studies 
the present in order that it may predict and prepare for the 
V future, and discovering that interdependence is the law of 
progress, it must not hesitate to shape its principles with refer- 
ence to a solidarity which shall grow more rather than less, 
stronger rather than weaker. 

Economics treats of Man as in Process of Development. — 
Few truths are more easily admitted or more persistently ig- 
nored than that of change in human life and condition. His- 
tory makes it real. Man now wanders about by force of 
necessity and age-long habit, now starves rather than be moved 
from his home. Land is now free to all, now parceled out with 
well-nigh absolute right of individual possession. The seem- 
ingly eternal features of the social structure are gone in a few 
generations. Nothing so invalidates theories, laws, ..general 



THE NATURE AND SCOPE OF ECONOMICS 7 

principles, institutions, and enterprises as this great law of 
change of which we seldom take full account. Take, for in- 
stance, bequests. Nothing is commoner than for a man to 
leave a legacy under specified and detailed regulations, binding 
for all time. One leaves money to endow a religious service 
in a language which in a few generations no one understands ; 
another founds a college to teach certain doctrines which in a 
century no one believes ; and so on indefinitely. These and a 
thousand other laborious efforts of statesman, warrior, or 
philosopher quite lose their worth for the future because their 
authors assumed that the future would be like their present. 
Even the wages system and the division between capital and 
labor which seem rooted in the constitution of society are scarcely 
two centuries old as a general system. One must never forget 
in the study of economics that the phenomena with which it 
deals are pervaded by the spirit of life, moving forward or back- 
ward, progressing or decaying, under those influences which 
control the rise and fall of social institutions. The science is 
biological rather than mechanical. 

The Laws with which Economics Deals. — The evolutionary 
character and complexity of economic phenomena, which ac- 
count for much of the charm of the subject, endow it also with 
unusual difiiculties. Conclusions true for one generation are 
invalid in the next. Terms and definitions appropriate to one 
stage of industry are misleading in a succeeding stage. Gen- 
eralizations valid for one nation and government are inappli- 
cable to another. Even those laws or uniformities which the 
science prizes as the finest product of its research are but state- 
ments of probabilities — declarations of what is most likely to 
occur for the mass of men in the long run under certain specified 
circumstances. 

In no department of knowledge, consequently, is there greater need of 
temperate statement and of that humility of mind which is the surest safe- 
guard against bigotry and dogmatism. No system of economics is appli- 
cable unchanged to all times and all places : the premises of the arguments 
change; the ingredients of nearly every problem present themselves in 
different proportions ; and the conditions of almost every question vary from 



8 OUTLINES OF ECONOMICS 

country to country and from generation to generation. The student must 
not expect rules of thumb by which he can decide offhand the economic prob- 
lems of the particular city or country district in which he is for the moment 
interested. No general treatise on economics can authoritatively decide 
the practical problems of particular times and places; although the econ- 
omist, before all other students, is forced to deal with practical problems. 
What such a treatise can do is to point out mistakes of logic common in the 
current discussions of economic questions, call attention to obscure factors 
— sometimes of great importance — which the practical man is likely to 
overlook, give solutions of typical problems which are likely to arise, and 
thus afford a training which will assist the student in solving practical 
problems for himself. 

The peculiar and distinctive office of the economic scientist, however, is 
to emphasize the less tangible truths, the remoter consequences, the deeper 
and consequently less obvious forces of economic society. The impulses 
of the moment, the immediate demands of the hour, the present "fact" that 
stares us in the face (and sometimes blinds us) , are not likely to lack vigorous 
champions; and to preserve the balance there is need of a craft of thinkers 
far enough removed from the battle to preserve the wider outlook, mindful 
of the lessons of the past, jealous for the rights of the future, insistent upon 
the less obvious truths. This is why economics so frequently appears to 
the practical man strained and academic. This impression arises from a 
difference of emphasis which in the main is as salutary as it is inevitable. 
The academic quality of the economist's work arises sometimes from igno- 
rance, sometimes from pedantry, but more frequently from his courageous 
insistence upon the importance of the less tangible truths and the distant 
consequences of present action. 

Is not economics, then, a science based upon natural law? 
The question is largely a verbal one. What do we mean by 
natural law? In the narrowest sense natural laws are the 
habits of nature which are subject to absolutely no variation. 
Such are gravitation and chemical affinity; and the sciences 
based upon such laws — astronomy, physics, and chemistry — 
were the first to develop, and have attained a maximum degree 
of exactitude. The term " science " is sometimes used in a 
way to imply only sciences of this character. These sciences 
are more properly known as exact sciences, and they are char- 
acterized by the fact that the relations with which they deal 
can usually be expressed quantitatively. 

When we come in contact with life, however, and especially 
with its higher forms, the exactness with which an astronomer 



THE NATURE AND SCOPE OF ECONOMICS 9 

predicts an eclipse or a chemist anticipates a reaction becomes 
impossible. Not that life is without laws ; very far from it. 
There is, in the first place, the basis of physical nature, with its 
perfect regularity, upon which all life rests and to which it 
must conform. Then, too, there are laws governing life 
directly and pertaining to it. These form the subject of the 
group of sciences known as biology. We must remember, 
however, that all we can say of natural laws is that they are 
habits, apparent regularities or uniformities in the succession of 
events ; not, so far as we know, compulsory necessities of nature. 
And the laws of Hf e seem to differ from those of inanimate nature / 
in that they are not quite invariable habits. Variability seems 
to be inherent in life, increasing as life rises in the scale of 
development. It is often assumed, to be sure, that these laws 
are as invariable as any other, and that this- seeming variability 
is only a greater complexity which we do not yet understand. 
However that may be, the result is the same for the present. 
The sciences of life are not exact in the sense we have defined. 
We must further note that in so far as a science deals with facts 
which seem to be governed by no invariable law, or whose law 
has not been discovered, it must content itself with a description 
of this part of its subject. Thus we have the term " descriptive 
science." We might better speak of the descriptive part of a 
science, for all sciences are able in part to reduce their facts to 
law. 

What has been said of the sciences dealing with life applies 
to an even greater extent to those sciences which deal with man. 
It is true that within certain limits man is governed by ab- 
solutely invariable laws. He is as much bound by gravitation 
as anything else, and if he falls over a precipice, we can predict 
the results as certainly as though a stone fell over. But, with- 
out entering the bog of discussion as to the nature of human 
freedom, we may safely assume, for practical purposes, that 
man is also, within certain limits, a law unto himself. No- 
where do we find an element of variability so great and so seem- 
ingly ultimate as here. We must remember, therefore, that the 
sciences which deal with man deal with a being who is modified 



lO OUTLINES OF ECONOMICS 

by his environment, but who has the power of modifying that 
environment by his own conscious effort. 

Let us consider very carefully what this means. It does not 
mean simply that man modifies his environment^ because he 
has been modified by it and so reacts upon it, just as things do 
when they come in contact. If we accept this view, we shall 
come to Herbert Spencer's theory of natural selection. The 
forces at work accomplish their own results, according to this 
theory, whether man will or will not, simply by natural action 
and reaction. This implies that man is modified by his envi- 
ronment, and that he in turn modifies that environment with- 
out conscious effort. This theory is based on an assumption 
that man has no power of initiating an influence, and consist- 
ently concludes that social development, like geological develop- 
ment, must be left to work itself out. Spencer, however, goes 
farther, and stoutly maintains that man, by conscious effort, 
especially by collective or state effort, not only does not help 
this development, but actually hinders it. In this the whole 
theory is abandoned, for it is plain that if man by conscious 
effort can hinder a process, he can help that process in the same 
way, if he only has enough wisdom and sense. These it is the 
purpose of science to give him. 

In opposition to the theory of natural selection, or unconscious 
development, has been urged the theory of artificial selection, or 
conscious development. Ages of natural selection made of 
the potato a lean, watery, unpalatable tuber ; a relatively few 
years of artificial selection made it a valuable food product and 
a table delicacy. Compare the development of domestic ani- 
mals in the last few years, under man's conscious guidance, with 
their slow and meager development in a state of nature. Man 
has precisely this power of consciously modifying the natural 
and artificial elements of his environment, and this power 
continually enlarges. 

So, when we ask if economics deals with natural laws, we 
really ask whether this being, whose activity in a certain line 
we are studying, is governed by such laws. If we mean by 
this to ask whether his action is characterized by absolutely 



THE NATURE AND SCOPE OF ECONOMICS II 

invariable habits, like the forces of physics, we must plainly 
answer, no. If man had no'power of initiative, or, on the other 
hand, were so perfectly rational as always to do the wisest thing, 
there would be a regularity in his action which might perhaps 
form the basis of a complicated, but exact, science. As it is, 
all social sciences are approximate and partly descriptive. 
There is much in man's action which is exceedingly (though not 
perfectly) regular, and hence we have general, though appar- 
ently not invariable, laws. There is a part of his action, how- 
ever, that seems as yet to be capricious, and we can only make 
note of it till we have more knowledge. 

The laws of economics are not comparable to the laws of 
inanimate nature in invariability, but they are of very general 
applicability, and are wholly in line with the action and intent 
of nature, and are, in this sense, " natural." But the laws of 
economics are not natural laws in the sense in which the word 
is often used ; namely, laws external to man and not at all the 
product of man. The laws of economics have been designated 
as social laws to distinguish them from those of physical science. 
Social laws describe tendencies, or regularities, which appear 
especially in the consideration of large masses of facts. Human 
mortality serves as an illustration. When and how a certain 
man, as A,, will die, is proverbially uncertain ; but when we 
speak of hundreds of thousands of lives, we can predict with such 
an approximation of accuracy that the vast business of life 
insurance can be built upon the regularity of the action of death. 

The foregoing discussion enables us to answer in a word the 
much-mooted question, " Is 'economics a science? " It is not 
an exact or mathematical science, though certain portions of 
the subject may possibly become so. It is an approximate 
and partially descriptive science, like all sciences dealing with 
man, or even with life. The inexactness of the social sciences 
is due to the very thing which gives them their supreme value, 
the nature of man and the greatness of their subject. 

The Relation of Economics to other Sciences. — We have 
already referred briefly to the relations between economics 
and some of the other sciences, but the topic is one which re- 



12 OUTLINES OF ECONOMICS 

quires fuller treatment. In one sense, economics may be said 
to be dependent upon practically every other science, since the 
discoveries in every field of knowledge almost inevitably react 
upon the economic life of man. Modern chemistry, to take a 
single example, has revolutionized some industries, wholly 
created others, and, through the agency of the pure-food laws, 
may claim most of the credit for entirely suppressing others. 
From psychology economics takes the axiomatic principles 
upon which the laws of value rest ; from physical science the 
law of diminishing returns, which plays a very important 
part in the theory of distribution ; and from mathematics the 
methods by which to ascertain how insurance may be safely 
supplied against accidents, death, and loss by fire. But it is to 
the sister sciences dealing primarily with man that economics 
is most vitally related. 

Man has been busy from the first in several lines of effort. 
He has talked, worshiped, fought, studied, and each of these 
lines of effort has developed its own faculties and institutions. 
For convenience we may arrange these in eight groups, as 
follows : language, art, education, religion, family life, society 
life, political life, economic life. Each of these is the subject 
of a science more or less developed. The group of society life — 
that is, the life of polite society, calls, parties, balls, and the 
like — has been studied but little, and we know few of its 
governing principles.^ Language, on the other hand, has a 
science which has attained to very complete development. 
The rest lie scattered between these extremes. 

A peculiar feature of these activities is that they are all of 
them collective activities, activities which one man cannot well 
carry on alone. This is obviously true of family and political 
life, language, and others ; and on careful examination it proves 
to be true of the rest. It is now admitted, after many experi- 
ments, that art and even religion do not thrive in solitude. It 

' An attempt to examine scientifically some, at least, of the phenomena of polite 
society has been made by a learned jurist, the late Professor Rudolph von Ihering, 
in his Zwcck im Rccht. Professor Thorstein Vebleii in his Theory of the Leisure 
Class gives a brilliant though half-satirical explanation of social conventions in 
terms of origins and survivals. 



THE NATURE AND SCOPE OF ECONOMICS 1 3 

would seem that if a man could do anything by himself, it would 
be to get a living ; but the study of economic history impresses 
us with the insignificance of all such effort and the inevitable 
tendency of men to drift together in their economic activity. 
If it were possible for men to live in isolation, every one of the 
eight lines of effort we have mentioned would soon dwindle 
into insignificance or altogether cease. So these sciences are 
all of them social sciences ; and as the sciences that deal with 
life are now grouped together under the name biology (science 
of life), so the social sciences may be grouped under the title 
of sociology, or the science of society, although some sociologists 
do not define the word " sociology " in this broad sense of an 
all-embracing science of human association. 

Economics, then, is a branch of sociology thus conceived. 
We have already defined it as the science which treats of those 
social phenomena that are due to the wealth-getting and wealth- 
using activities of man. We may speak of the wealth-getting 
and wealth-using activities in all their relations as economic 
life or economy. Accordingly, economics is the science which 
deajs with the economy of man. A useful distinction in lan- 
guage is thus made between economy, the life itself, and eco- 
nomics, the science dealing with that life. If this distinction 
could always be observed, much confusion would be avoided. 

We have economies of various sorts : the economy of an 
individual, of a family, a tribe, a city, a state, or a nation, and 
we have, correspondingly, many economic units. The domi- 
nant unit in ancient Greece, for example, was the household, 
which included the family and all the slaves and other depend- 
ents. These lived together and formed a little group by them- 
selves. The economic life of Greece meant, largely, a sum of 
the economic activities of these households, each of which 
strove to be sufficient unto itself. It is interesting to know that 
many a well-managed Southern plantation before the Civil War 
endeavored to produce nearly all the means of life on the planta- 
tion, and in this respect, as in others, resembled a Greek house- 
hold. But as time has progressed, these old groups have 
been partially dissolved, and in many instances in modern 



14 OUTLINES OF ECONOMICS 

times the individual, in his economic activity, constitutes a 
unit, although the family is still the prevalent economic unit. 
It is a natural outcome of economic progress, as already ex- 
plained, that the relations between these units have multiplied 
indefinitely in number and in importance. This is simply 
another way of describing the growing interdependence of men. 
Economics deals especially with the mutual relations of econo- 
mies of all kinds, private and public. It is chiefly, if not 
exclusively, a science of human relations, and without these 
relations could not exist. 

Because of the organic connection of these relations in their 
common origin, man, and because economics deals with the 
individual as he is, and not with an artificially simplified " eco- 
nomic man," it is impossible wholly to dissociate the social 
sciences, and particularly impossible to divorce economics 
completely from ethics and politics. This does not mean that 
these sciences are all one and cannot be profitably subdivided. 
On the contrary, because of the limitations of the human mind, 
they must be studied separately so far as is possible. Scientific 
progress, like industrial progress, comes largely through spe- 
cialization and the division of labor. Man cannot profitably 
study things in general. What it does mean is that there is 
some territory common to all these sciences, and that occa- 
sionally the economist is forced to pass ethical judgments and 
to decide political questions. In the consideration of railway 
rates, for instance, the economist may be compelled to pass 
judgment upon what is just and reasonable, and he discovers 
upon investigation that by common consent what is fair or 
reasonable must be decided largely upon economic grounds. 
The same is true of the apportionment of taxes, in which subject 
ethical, legal, and economic questions are inextricably inter- 
woven. Commercial policies, restrictive regulations,, and sump- 
tuary laws have been the very stuff and subject-matter of the 
science of economics from its first beginning. In analyzing 
the progress of the past or the conditions of the present, we are 
forced to pass judgment upon the success or failure of many 
laws and policies which are still in force or under active dis- 



THE NATURE AND SCOPE OF ECONOMICS 1 5 

cussion. Many of these must be indorsed or repudiated either 
solely or largely upon economic grounds ; and because of these 
facts, the economist cannot, even if he would, refrain from pass- 
ing judgment upon laws and political policies. Nevertheless, 
as was stated before, economics does not undertake the complete 
and systematic study of law, ethics, and politics, and its conclu- 
sions must almost always be supplemented by non-economic 
considerations which the economist may not have taken into 
account. 

Principal Divisions of Economics. — This view of the in- 
evitably practical character of economic science is carried out 
in the treatment of the subject in the following pages. The 
history of the evolution of economic society, sketched in Book I, 
is followed, in Book II, by a discussion of the production, con- 
sumption, exchange, and distribution of wealth. These sub- 
jects are treated in close connection with those illustrative 
economic problems of which the so-called " economic theory," 
at its best, is but a more comprehensive and consequently more 
abstract analysis. Book III has been reserved for the subject 
of public finance, and in an appendix is given a brief sketch of 
the history of economic thought. 

QUESTIONS 

1. What is the most essential characteristic of economics? Define eco- 
nomics. 

2. Is man or goods the more prominent thing in economic study? Does 
economics teach the student how to succeed in business? 

3. What determines ultimately whether a man is poor or not? What 
kinds of poverty are there ? 

4. What is meant by "dear labor"? Is it a good thing for society in 
general? for employers in general ? for an individual employer? 

5. What is the difference between natural and artificial selection ? Which 
applies to human society ? 

6. Are practical ethical and political judgments the chief ends and prod- 
ucts of economic science? 

7. Is economics concerned with the negro question? bank notes? prohibi- 
tion? anti-trust laws? race suicide? protection? 

8. What is a scientific law? Contrast with a statutory law ; with a moral 
law; with the laws of mathematics. 



1 6 OUTLINES OF ECONOMICS 



REFERENCES 



Cairnes, J. E. The Character and Logical Method of Political Economy. 

CossA, L. An Introduction to the Study of Political Economy. 

Dunbar, C. F. "The Academic Study of Political Economy," in his 

Economic Essays. 
Ingram, J. K. A History of Political Economy. Chap. vii. 
Keynes, J. N. The Scope and Method of Political Economy. 
Marshall, Alfred. Principles of Economics, 6th ed.. Appendixes C and D. 
Mill, J. S. Essays on Some Unsettled Questions of Political Economy. 
SiDGWiCK, Henry. The Scope and Method of Economic Science. 
Wagner, Adolph. "On the Present State of Political Economy," 

Quarterly Journal of Economics, Vol. i. 



CHAPTER II 

THE CHARACTERISTICS OF THE PRESENT 
ECONOMIC SYSTEM 

Our Environment. — Lying back of all of our economic ac- 
tivity is the fact that we live in an environment in which the 
things that we desire are not furnished spontaneously in un- 
limited quantities. Whether it be looked upon as due to the 
niggardliness of nature or to the insatiability of human wants, 
the fact is that, for the most part, the material things that we 
use must be economized. We must put forth effort and exer- 
cise self-denial in order to enjoy the good things of life. Those 
human arrangements which help to determine how much of ef- 
fort, of self-denial, and of enjoyment is to fall to the lot of each 
of us are the characteristics to which we now turn our attention. 
There are, however, a number of social institutions which do 
not fall within the scope of the present chapter. We deal here 
only with the social conditions directly underlying our economic 
activity, which is but one aspect of our social life. We must 
leave to the sociologists and other students of society a discus- 
sion of such topics as the family, religion, morality, ceremonial 
institutions, and the nature of government, although, to be sure, 
these also have their effect upon the economic sphere and are in 
turn affected by it. 

Private Enterprise and State Activity. — We live in an age 
when private enterprise, for the most part, is relied upon to 
furnish us with the necessities and enjoyments of life. The 
cultivation of the soil, the exploitation of the mines, transport, 
the various stages of manufacture, and the distribution of the 
finished product are all left mainly ^ to private initiative. The 

1 This applies especially to the United States and England so far as transport 
is concerned ; it would not hold true of every country. 
c 17 



1 8 OUTLINES OF ECONOMICS 

discovery of new processes, invention, and experimentation are 
carried on mostly by private individuals or corporations who 
take upon their own shoulders the risk of failure. The State, 
on the other hand, participates in this activity in a variety of 
ways. It maintains order, promotes the public health and safety, 
provides roads, and takes complete charge of some industries. 
In its educational institutions the State, through its agents, un- 
dertakes various experiments, and encourages the growth and 
diffusion of knowledge, an indispensable condition of continuous 
advancement in our economic life. The state university and the 
experiment farms may be mentioned, and also the large and 
extremely useful Department of Agriculture of the United States, 
with its annual expenditure of about twenty million dollars. 
Certainly in the vast majority of the enterprises with which we 
are familiar, private and public activities are combined in vary- 
ing proportions. 

In speaking of "State" activity, the reference is to organized society 
acting through any one of the various governmental agencies, such as the 
township, city, or national governments, and not merely the political unit 
which we know in this country as the state government. The term " govern- 
mental activity" is sometimes employed but is less desirable. The word 
"government" suggests to the ordinary mind a power apart from and 
superior to the people — a restraining or punishing power — whereas the 
modern concept of the State is that of a cooperative institution, main- 
tained to safeguard and promote the general welfare. "Private" activity, 
it should be noted, is a broader term than "individual" activity. It 
includes all forms of joint or associated action except those which consti- 
tute the activities of the State. 

Let us take the case of an industry which is as nearly private, 
perhaps, as any we can find — that of agriculture — and notice 
the part which public activities play in securing the farmer's re- 
sult. First, we may say that the farmer owns the farm that he 
cultivates ; this is private property. But how comes it that the 
farm is his? Why does not a stronger man drive him off and 
take the farm himself? Plainly because the State protects him 
in the possession of the farm. When he bought the farm, he took 
his deed to a government official, who recorded it, and thus gave 
him an additional guarantee of possession. A neighbor's dog 



THE PRESENT ECONOMIC SYSTEM 19 

kills his sheep, and an appeal to the State compels the neighbor 
to redress the grievance. Another, far below, dams a river and 
backs the water up so that it overflows his land. Another appeal 
to the State removes the dam or secures compensation. When 
wheat is raised, the farmer hauls it to market by a road built, not 
by private, but by public, activity. The railway lowers the price 
of his wheat by a discriminating rate, and again government in- 
terferes in his behalf. But manifold and important as are the 
regulations of the government. State activity seems very much 
restricted when we reflect that it might extend over the entire 
industrial field. Today the distinctive characteristic of our eco- 
nomic life is private, not public, enterprise. 

Division of Labor and Exchange. — It is commonly taken for 
granted that every man should prepare himself for some special 
occupation, that one should plow while another builds or sings. 
Hardly any civilization seems possible without some industrial 
specialization, but our own age is peculiar on account of the ex- 
tent to which this has been carried. The introduction of machin- 
ery and the development of large-scale production have split up 
the work of men so minutely that the products which they turn 
out are not only of no immediate use to themselves in most cases, 
but they are also useless to any one else until combined with the 
results of other men's labor, often performed years before or 
afterwards. It is a long and complicated process from the man 
who mines the ore which is to reappear in a steel plow, to the 
man who bakes the bread. This specialization of employment 
has some far-reaching results : 

I. It implies the exchange of goods. If we produce things 
we do not need, we must find some one else who does want them 
and some one who has the things we desire. Money, banks, and 
transportation agencies could largely be dispensed with if each 
family produced for itself alone. There would be none of the 
complex problems that center about the question of how much 
each of us is to receive in exchange for his services. One of the 
striking characteristics of this process of exchange is the great 
extent to which it is automatic. There is no government official 
whose business it is to discover how much of each commodity 



20 OUTLINES OF ECONOMICS 

will be needed, and to direct that that amount shall be produced. - 
Men are legally allowed to engage in almost any undertaking 
that attracts them, and yet we take it for granted that somehow 
things will get produced in the proper proportions. A hundred 
men are set to work in a factory making nothing but hats, many 
more than they or their friends can use, but the manager has 
faith that heads will be found to wear them all. Farmers con- 
fidently proceed to raise wheat, never troubling themselves 
about the grinding and baking. Neither workmen nor em- 
ployers in general know why wages are as they are. Men lend 
money or goods, now for one price, now for another, but few 
know why they demand interest or why the rate changes. 
These processes go on visibly before us, but the governing laws 
are hidden except to the careful investigator. In this respect 
they are like the laws of physiology. We eat and digest our 
food, but how many people know how or why digestion takes 
place? It is easy, however, to overemphasize this idea, for 
a great deal of our economic activity is conscious and volitional. 
When we decide to make a law or levy a tax, we do it consciously, 
considering arguments, and finally will to do the thing in ques- 
tion. And even in business undertakings there must be much 
careful study of the probable demand for various kinds of goods 
and of the most economical ways of producing them. 

2. The specialization of work and exchange of goods just 
referred to necessarily imply that mutual dependence briefly 
considered in the preceding chapter. Instead of a number of 
distinct, self-sufficient units, we have a coherent society where 
one individual relies upon many others to complete his own one- 
sided economic activity. A strike of street-car employees, or 
of teamsters, or the destruction of an electric lighting plant, 
would each send a shock of inconvenience through a community. 
A prolonged railway strike would be felt as a national misfortune. 
Indeed, this interdependence is international in its scope. Eng- 
land relies on other nations to send her food in exchange for her 

> The government does help, however, by collecting and publishing information, 
such as crop reports, statistics of the amount of cotton ginned, consular reports 
as to opportunities in foreign markets, and in various other ways. 



THE PRESENT ECONOMIC SYSTEM 21 

manufactured products, and many a German workman would 
be in distress if our exports of cotton or copper should suddenly 
cease, as is happening in the great European War, in progress 
at the time that this is being penned. The United States is more 
self-sufficient economically than many other nations, but we 
are nevertheless dependent upon international trading for our 
supplies of many things. 

Economic Classes. — In part, also, the specialization of work 
is responsible for the division of society into classes, but only in 
part. The differences in the work of the carpenter, machinist, 
and railway brakeman do not result in the formation of classes 
of a higher and lower rank. On the other hand, the professional 
brain worker enjoys some social esteem that does not fall to the 
lot of the manual worker. But doubtless the most important 
basis of social classification is the possession of wealth. The 
power to spend freely, while not the only test, is today the most 
widely recognized test of social status, regrettable as this may be. 

Private Property. — We proceed now to examine the founda- 
tion stones of this system of private enterprise. Private prop- 
erty is the most important of these. For our present purpose 
we may define private property as the exclusive control over valu- 
able things by private persons. It is to be distinguished from mere 
possession. The possessor has the use of the thing for the time 
being, but unless he is at the same time the owner, he is depend- 
ent upon the will of another for the use of it. Ownership implies 
the right of excluding other persons from the employment of a 
thing. The exclusive right must be recognized and guaranteed 
effectively by third parties. If the exclusive right of control 
over some valuable thing is asserted simply by the strength ot\ 
one's right arm, the right of private property is not thereby 
established. The exclusive right of control must be recognized 
by others and must be maintained by them. 

Over against private property we have public property, and 
there are some things, such as air, which fall in neither of these 
categories. The sphere of private property at present includes, 
not only food, clothes, and other things of personal use, but also 
the instruments of production — land, buildings, and machinery. 



2 2 OUTLINES OF ECONOMICS 

In the most important productive processes the tools are in gen- 
eral not owned by the persons who use them. 

It may be said that property is the chief seat of social authority. As 
property carries with it the exclusive right to control things, others may have 
access to these things only on conditions named by their owners. If we 
look about us, we find men organized and acting together under direction 
for purposes of production. In a factory we find an organization of men 
like that of an army. We discover men moving here and there and per- 
forming arduous tasks in obedience to command. If we examine the nature 
of the authority which some thus exercise over others, we shall find that it 
resides in property. The law of the land to some extent establishes the 
authority of man over man; but where one man obeys another because 
the law in so many words tells him to do so, we find a hundred men obeying 
others because these others have the authority which resides in exclusive 
control over valuable things. Indirectly this latter sort of authority rests 
back upon the laws in so far as these are responsible for the establishment of 
property. But the chief seat of authority in society is based only indirectly 
upon the government ; it rests immediately upon private property. 

The right of private property is one so fundamental in our 
modern life that we scarcely think of it as a creation of man, 
maintained by constant vigilance on the part of the State, and 
subject to human modification. It seems like bed rock, an ulti- 
mate right, needing no other justification than its own obvious- 
ness. When a custom has obtained very widely and is deeply 
rooted in human life there is often a tendency to claim it as a 
" natural right." But the right of private property as we know 
it now did not always exist. It has not always been so extensive 
or exclusive as at present. This is especially marked in the case 
of individuals, whose claims as opposed to those of the tribe were 
at first slight and vague ; but these claims gradually grew, 
especially in the case of the chieftain, until tribal or communal 
rights broke down before them. The time was when a Scottish 
clan had absolute right to the territory it occupied, and no chief- 
tain, however powerful, could have abridged that right. Now 
there are beautiful tracts of country in Scotland which are almost 
denuded of their agricultural population because the owners, the 
descendants of these same chieftains, preferred to raise game on 
their estates. All are familiar with the liberty generally allowed 
in this country of hunting and fishing on private estates. This 



THE PRESENT ECONOMIC SYSTEM 23 

is unheard of in Europe. Slowly, however, we are extending 
our property claims to game and fish, and the former leniency 
of ownership is disappearing. 

But the modern State is continually placing limitations and 
restrictions on the right of private property. Our cities regulate 
the height of buildings and prescribe the material from which 
they must be made and the kind of plumbing which must be in- 
stalled. Restrictions of the uses to which land may be put are 
common, and no one can use his property in ways that constitute 
a public " nuisance." The nature and extent of these changes 
in private property must be controlled by the State in the public 
interest. How far interference with the right is justified cannot 
be discussed in general terms : such a discussion must deal with 
the specific problems of municipal ownership, railway regula- 
tion, and innumerable others. The point to be emphasized here 
is that in solving such problems the mere fact that a proposed 
solution restricts or enlarges the right of private property cannot 
in itself be given much weight. 

Trademarks, Copyrights, and Patents. — These are legal 
arrangements whereby exclusive privileges are awarded in return 
for certain services to society. These privileges become a special 
form of private property. Their justification lies in the fact 
that they are a means of promoting " the progress of science and 
useful arts." It must be remembered, however, that all such 
progress is a historical product. The telephone, for example, 
was preceded by a century of scientific invention and discovery, 
most of it poorly remunerated. The telegraph was, similarly, 
the result of the careful plodding industry of scores of men. 
Professor Henry, of Princeton College, whose services in connec- 
tion with the completion of the telegraph were most distinguished, 
conscientiously refused to take out any patent. It often happens 
that several persons almost simultaneously and independently 
make the same discoveries and inventions. Our patent laws 
seem frequently to reward the man who makes the finishing 
touches which lead to the utilization of a long line of work. But 
it is the hope of being the one who may give the practical turn 
to an idea that lures many a man on to undertake the laborious 



24 OUTLINES OF ECONOMICS 

task of doing the extensive experimentation often necessary to 
place an article on the market. 

In order that patents and copyrights may not become the 
bases of burdensome monopolies, they are of limited duration. 
Patents in the United States run for seventeen years, and copy- 
rights for a period of twenty-eight years. Copyrights may be 
renewed for another term of the same length. These legal privi- 
leges have resulted in an enormous amount of litigation and have 
given rise to special problems. One of these is the question of the 
extent to which the manufacturer of a patented article should 
have the right to control the price after the article has left his 
hands. It is frequently asserted that owners of patents should 
be compelled to permit other persons to use them upon the pay- 
ment of royalty, so as to promote competition in manufacture. 
But there is some danger that such legislation would defeat the 
primary object of the patent system. Even with the exclusive 
right to manufacture an article it frequently requires a long 
struggle to make an invention a commercial success. It has also 
been suggested that the United States government should re- 
serve the right to purchase a patent, but it is improbable that 
this right, if reserved, would be often exercised. 

Inheritance. — Inheritance is often regarded as a necessary 
part of the right of private property, and it is true that the entire 
abolition of the right of inheritance would result in a great en- 
largement of public property at the expense of private property, 
unless gifts were used to replace inheritance as a means of trans- 
ferring property from one generation to the next. But, in 
truth, property and inheritance are two distinct rights. Private 
property is an exclusive right of control, whereas inheritance is 
the transmission of this right from one generation to another. 

As in the case of private property itself, the right of inheritance 
is not recognized today as absolute. Detailed regulations exist 
on our statute books regarding the making of wills and regulating 
the descent of property where no will is made, and there is an 
increasing tendency to limit the right of inheritance by taxation. 
That which seems a mere natural right at one time seems a wrong 
at another, as is illustrated in the changing ideas and practices 



THE PRESENT ECONOMIC SYSTEM 25 

concerning the share of a father's estate to be inherited by the 
oldest son. 

Contract. — Hardly second in importance to the right of pri- 
vate property is the right of contract, for the maintenance of 
which we are equally dependent on the State. Some sort of 
contract lies at the basis of all associated activity. To secure the 
condition of such activity, it is necessary, first, that men should 
be allowed to bind themselves ; and, second, that they should 
be compelled to abide by the agreement thus entered into. The 
entrance into a valid contract is ordinarily voluntary, but once 
entered into with due formality, the State will use its superior 
power to enforce it. To the anarchist this seems oppressive, and 
it is true that a state of society is conceivable in which the ele- 
ment of force might be removed from the idea of contract, but 
something else would have to be substituted to make the keeping 
of agreements the general rule. There are doubtless many 
people living today with whom the feeling of honor or the fear 
of social disapprobation would be sufl&cient for the enforcement 
of contracts, just as these persons might not need the threat of 
a jail sentence to keep them from stealing. 

The economic ties which hold men together in industrial society are, on 
their legal side, very generally contracts. The organization of an industrial 
corporation implies many contracts. Our property is acquired very largely 
through contract, and through contract we determine the conditions under 
which we do our work, such as the length of the working day. The continu- 
ity of our economic life rests upon contracts, which bind together past, 
present, and future. Still, all that we have by no means comes to us through 
contract. " Contract " does not exhaust the significance of parentage, home, 
and education, and much wealth changes hands through gifts and inheritance. 

Laws are frequently enacted regulating contract in the general 
interest. This is especially marked in labor legislation, which 
will be discussed in another chapter. Certain contracts cannot 
be enforced by law, because they are held to be against public 
policy, as, for example, gambling contracts and contracts in 
restraint of trade. In some cases statutes make it illegal to 
enter into such contracts. 

Vested Interests. — A few words should be said about vested 



26 OUTLINES OF ECONOMICS - 

interests.^ Vested interests are legally recognized pecuniary 
interests which cannot be impaired by public action without 
indemnification. Vested interests generally arise through prop- 
erty and contract. Outside of property and contract, however, 
there may be vested interests. Leeds was compelled by a feudal 
arrangement to grind its corn, grain, and meal at the lord's mill 
till well on in the last century, and finally had to pay £ 13,000 to 
terminate this obligation. When Prussia bought the railways, 
the railway presidents were indemnified for the loss of their posi- 
tions by large payments ; in other words, their offices were looked 
upon as vested interests. England is the classic land of vested 
interests. An office in the army was until recently looked upon 
as such, and so was an appointment in the established church. 
It is generally held that keepers of public houses in England li- 
censed to sell beer and spirits have a vested interest in their busi- 
ness, so that they must be indemnffied if their licenses are taken 
from them. Workingmen have frequently claimed that they 
have a vested interest in the advantages which their skill in their 
trades gives them, and that if through industrial changes this 
skill ceases to be of as great value as formerly, they ought to be 
indemnified and in some way their former income continued. 
This claim of the workingmen, however, unlike many other 
claims put forward in the name of vested interests, has not re- 
ceived recognition, either by Parliament or the courts. Vested 
interests, apart from property and contract, are of less signffi- 
cance in the United States than in most countries, but they 
may become of more significance in the future. 

Freedom. — The freedom to do certain things is legally 
guaranteed at the present time, such as moving from one part of 
the country to another, choosing one's own occupation, and 
acquiring property. These, together with the absence of slavery 
and of imprisonment for debt, are characteristic features of the 
present economic order as distinguished from past conditions. 
The right to manufactyre and sell what and when one pleases is 
also comparatively recent. It has often been greatly limited by 
despotic governments, and has been made a matter of sale for 

'The term "vested rights" is also used. 



THE PRESENT ECONOMIC SYSTEM 27 

the purpose of raising revenue. Such Hmitations gave rise to 
many abuses, and our own time has seen the abolition of an im- 
mense number of hampering and vexatious restrictions often 
designed for extortion rather than for the promotion of private 
enterprise. So far as the absence of legal restrictions on the 
actions of individuals is concerned, the past century has been 
distinctively an age of economic freedom. 

Restrictive laws, however, are not the only limitations on eco- 
nomic freedom. The system of private property itself means 
that certain individuals in the community have power to com- 
mand other people to work, and the lack of an income under our 
present regime implies the lack of the real freedom to do things. 
The cost of a railway ticket may be quite as effective as a legal 
barrier would be in preventing movement from one state to an- 
other. We say involuntary servitude, except as punishment for 
crime, has been abolished, yet men are compelled to work by 
the threat of economic distress, in most cases quite as effectively 
as by means of the slave-driver's whip. Again, the choice of an 
occupation is free according to the law, but we may find that a 
long and expensive course of training is necessary, or trades- 
unions ef[ective*ly limit the number who can learn a given trade. 
The right to establish enterprises is granted to all alike according 
to the law, but today most persons would find it difficult and 
hazardous to embark upon the refining of oil or the manufac- 
ture of steel. For most men, the freedom to establish new en- 
terprises has been growing less and less in this era of large-scale 
production. 

This leads us to a distinction between what have been called 
negative freedom and positive freedom. Mere absence of re- 
straint (negative freedom) is one thing, and the power to develop 
our activities to the fullest extent (positive freedom) is a very 
different thing. Legal restrictions may actually be the means 
of increasing positive freedom. Thus, a library placed at the 
disposal of the public without rule or regulation would result in 
a smaller total utilization of the books than one in which the ob- 
servance of certain rules is strictly enforced. All laws which 
limit the power of the strong to oppress and which help to open 



28 OUTLINES OF ECONOMICS 

the gates of opportunity to all must of necessity increase positive 
freedom. The newer idea of freedom aims at the development 
of such social arrangements that sane and complete lives will be 
possible for the largest number of persons. 

Competition and Markets. — As a result of the legal conditions 
that have been mentioned, we find men engaged in many kinds 
of rivalry. Our economic society is often called " competitive " 
for this reason. But this term does not apply to all forms of 
rivalry, for economic competition is based on private property and 
free contract. There might still be conflicts between races and 
nations if private property and free contract were abolished. 
The men of any single nation might still vie with one another to 
prove their superiority in the eyes of womankind or to gain posi- 
tions of public honor and power. The kind of competition which 
is distinctive of the present economic order is the all-pervading 
endeavor to obtain the largest possible amount of wealth in ex- 
change for commodities produced or services rendered. If we 
except the idlers, the parasites, and the cheats, men are every- 
where endeavoring to discover what other people urgently 
want, and then to satisfy these wants in the most efficient manner 
possible. Moreover, they attempt to give as little as possible 
of their own products in exchange for the things they themselves 
desire. Business competition thus has two sides : rivalry in 
rendering a service, and alertness in exacting a return. Each 
individual takes part in the competitive contest in two ways : 
first, as a seller of goods or services, in which case he finds that 
others are anxious to render the same service ; and second, as a 
buyer of the things he wants, in which case he finds that these 
same things are sought by other people. 

The intensity of the competitive struggle is subject to a good 
deal of variation. At times it may be characterized as cut- 
throat, where the slashing of prices has for its object the elimina- 
tion of one or more of the contestants. But in most lines of 
endeavor many competitors may continue to exist side by side 
indefinitely, each being confronted by the ever present threat 
that, if his service becomes very poor, some other man will our- 
strip him. Various as may be the character of competition, now 



THE PRESENT ECONOMIC SYSTEM 29 

predatory, now a friendly rivalry, there is no resting place in the 
contest unless one secures some special privilege as a shelter. 
He who is energetic, and wins success in a certain line of business, 
must continue to defend himself from a host of imitators who are 
anxious to snatch his gains from him. Most of the competitors 
are successful in getting something, some more than others, but 
many fail altogether. These last, the inefl&cient, whether made 
so by sickness, by inherited weakness, or by lack of proper train- 
ing, fall by the wayside and must be cared for by private charity 
or by the State. The process is cruel in many of its details, but 
there is also a beneficent aspect in its sifting out of the incompe- 
tent and in its encouragement of the strong. 

Here, again, the automatic character of the present industrial 
system manifests itself. It is through competition and bargain- 
ing in the market that the prices of goods and services are fixed, 
and it is to the variations in these prices that men look for indi- 
cations as to what people want. Price is the universal barometer 
that indicates changes in the demand for goods of all kinds. 

Fair Competition. — Competition has been spoken of as a 
struggle, a contest, accompanied by success and failure, elation 
and disappointment. But the State sets limits to the rivalry, — 
it makes regulations and acts as an umpire to compel fair play. 
It attempts to eliminate fraud and brute force ; it trains the ris- 
ing generations for an entrance into the struggle by a system of 
free education ; it insists that no person shall sacrifice the life 
and limb of another in the rush for wealth ; and it protects chil- 
dren and women when they seem compelled to labor under un- 
healthful conditions. Those who fail entirely in the struggle it 
tries to rescue from suffering. Libelous and fraudulent state- 
ments about a competitor's business are illegal. So are efforts to 
induce his customers or employees to break their contracts with 
him. Competition designed to drive a rival out of business is 
illegal, whatever its methods, if it is prompted by sheer malice or 
is part of an effort to establish a monopoly. The Federal Trade 
Commission, established in 19 14, is empowered to issue orders 
restraining the use of unfair methods of competition by persons 
engaged in interstate commerce. In short, the State aims to 



30 OUTLINES OF ECONOMICS 

raise the plane or ethical level of competition, changing it from 
brutal warfare into a contest in which there are prizes for all, but 
in which the prizes are graded according to the energy and ability 
of the contestants. 

Cooperation. — The statement that our age is one of competi- 
tion is misleading if it gives the impression that every individual 
is always struggling against all of his fellows. On the con- 
trary, the achievements of modern industrial civilization would 
be impossible without a far-reaching cooperation between in- 
dividuals. Employers and employees may quarrel and bargain 
about the wage contract, but when they have settled their rela- 
tions for a week or a year, they become cooperators for that 
period in the conduct of the business enterprise in which they are 
engaged. Again, there is an unconscious cooperation between 
those who work upon a commodity in the different stages of the 
process from raw material to finished product. The division of 
labor itself is cooperation on a splendid scale. Competition 
merely determines the conditions on which the cooperation takes 
place. If these conditions could be determined in some other 
manner, it would be possible to conceive of the elimination of 
competition from our industrial system, but cooperation itself 
is so vital and fundamental that its elimination would mean a 
return to barbarism. 

Monopoly. — Everywhere in the industrial field the tendency 
toward monopoly is present. Business men endeavor so far as 
possible to shelter themselves from the effects of the competitive 
struggle by means of some privilege, but if none is to be foimd, 
and if competition becomes very keen, they endeavor to combine 
with other business men. But while this attempt to escape com- 
petition is universal, it is only under certain conditions, not gen- 
erally present, that it is at all likely to succeed. The possibility 
of success is least in agriculture and in mercantile business, where 
new enterprises are started rather easily because no special privi- 
leges stand in the way and because no very large capital is re- 
quired to work efficiently. It is greatest in mining and trans- 
portation, where special privileges are present and where large 
fixed capital is required. Scarcely anywhere is it possible wholly 



THE PRESENT ECONOMIC SYSTEM 31 

to escape competition, and we are still warranted in speaking of 
the present era as a competitive rather than a monopolistic age. 

Side by side with the growth of monopoly there is an increase 
in government control of industry. The desire of the business 
man is to be uncontrolled, but wherever he succeeds in throw- 
ing off the control exercised by his competitors, he inevitably 
substitutes that of the government. 

Custom. — Custom plays an important part in our economic 
activity as well as in every other department of social life, al- 
though its sway is not so marked as in former ages or among 
primitive peoples. The custom of giving gratuities, or tips, to 
servants is in many places so strong as to have almost the force 
of law. Again, today much of our personal expenditure is con- 
trolled by what custom has declared to be proper rather than by 
any act of our own individual reason. Any attempt to lower 
wages which would make impossible the maintenance of a cus- 
tomary standard of living would be stubbornly resisted. And, 
as we shall see in a later chapter, the " good- will " of a business, 
which is often a durable source of business profits, is built up, 
in large measure, on its ability to get people into the habit or 
custom of trading with it. Custom is the result of habit, and is 
continually broken into by our tendency to imitate a leader who 
proposes a new line of action. While custom may have its benefi- 
cent aspect in preventing hasty and impulsive changes, it fre- 
quently retards progress and causes our legislation and judicial 
decisions to lag behind industrial development, 

QUESTIONS AND EXERCISES 

1. Give further illustrations of the difference between positive and nega- 
tive freedom. 

2. Describe the property relations existing in the Amana Society, or in 
other communistic groups. 

3. What regulations concerning the inheritance of property are in force 
in your state? 

4. To what extent are gambling contracts valid? Why does the law 
differentiate them from ordinary business contracts? 

5. Compare the legal freedom of workingmen today with the conditions 
described in the Wealth of NaliPiis, Book i, Chap, x, Part ii. 



32 OUTLINES OF ECONOMICS 

6. Compare the rights of patentees in Bauer v. O'Donnell, 229 U. S. i 
(1912), with those allowed in Henry v. Dick Co., 224 U. S. i (1911). 

7. What do you regard as " unfair " advertising ? Give examples. 

REFERENCES 

Bliss, W. D. P. Encyclopedia of Social Reform (new ed.), article on Amana 

Community. See also on same subject, Ely, R. T., in Harper's Monthly 

Magazine, October, 1902. 
Ely, R. T. Property and Contract, in their Relations to the Distribution of 

Wealth, Vol. i, pp. 94 and ff.; Vol. ii, pp. 755-821. 
Green, T. H. "Liberal Legislation and Freedom of Contract," in his 

Works (edited by Nettleship), Vol. iii. 
Lewinski, J. S. The Origin of Property. 
Mill, J. S. On Liberty, Chap. iv. 

Mill, J. S. Principles of Political Economy, Book ii. Chaps, i. and ii. 
Nicholson, J. Shield. Principles of Political Economy, Vol. i, Book ii. 

Chaps, ii-viii. 
Reports of the United States Commissioner of Patents. 
Rogers, E. S. Good Will, Trade Marks, and Unfair Trading. 
SiDGWiCK, Henry. Principles of Politual Economy, Book ii. Chap. xii. 
Stephens, J. F. Liberty, Equality, and Fraternity. 

Webb, Sidney and Beatrice. Industrial Democracy, Vol. ii, pp. 562-572. 
Wyman, Bruce. The Control of the Market. 



CHAPTER III 
THE EVOLUTION OF ECONOMIC SOCIETY 

The evolution of economic society is but one of many points 
of view from which the development of mankind may be consid- 
ered. The history of literature, the history of government, the 
history of religion, each treats of man in one line of his activities. 
Many thinkers have considered the economic activities of man- 
kind as the one fundamental factor in social progress, deter- 
mining in the long run even our moral and religious ideas. 
But human life is complex, and it is improbable that any simple 
explanation suffices for all of its aspects. The economic factor, 
however, is clearly of fundamental importance in the sense that 
the higher things in life cannot be gained if man's entire time 
is spent in getting a mere subsistence, so that economic progress, 
or increasing control over the forces of nature, must accompany 
general social advancement, at least for the mass of the commu- 
nity. Under primitive methods of production, only a select few 
can have the leisure which is a necessary condition of a high stand- 
ard of living. The greater the total social product, the better 
the possible satisfaction of the true economic wants of all ; 
and, other things being equal, the more satisfactory the founda- 
tion on which to rear a high democratic civilization. 

The Economic Stages. — Many attempts have been made to 
divide economic history into different stages through which 
mankind passed in arriving at modern industrial civilization. 
These attempts have been the subject of lively criticism, but 
it appears that the classification which in the past has been 
most widely used is still, with some modifications, the most 
serviceable, and in the main, this will be followed in the present 
chapter. 

The basis of this classification is the increasing power of man 



34 OUTLINES OF ECONOMICS 

over nature. This is the fundamental fact in man's economic 
development, and his position in the scale of economic civiliza- 
tion is higher in proportion as this power over nature increases. 
Increasing control of nature is accompanied by changes in man 
himself, especially by a growth and diversification of his wants, 
so that we may say that economic civilization consists largely in 
wanting many things and in learning how to make and use them. 
From this standpoint economic history may be divided into the 
following stages : (I) Direct Appropriation ; (II) The Pastoral 
Stage; (III) The Agricultural Stage; (IV) The Handicraft 
Stage ; (V) The Industrial Stage. 

I. Direct Appropriation 

Primitive man depends upon finding things, not upon making 
them. This does not mean that the lowest examples of man- 
kind that we know do absolutely nothing in the way of trans- 
forming the materials of nature for use. The lowest types know 
the use of fire and have rude tools, but, nevertheless, the farther 
back we go, the more complete do we find the reliance on nature. 
One cannot read descriptions of the Negritos, Veddahs, Fuegians, 
or native Australians without being impressed with the simi- 
larity between the economy of these peoples and that of the 
lower animals. But there are many tribes commonly regarded 
as savages that show a great advancement over those that 
have been mentioned. Among the North American Indians, 
for example, we find a rude sort of cultivation of the soil along 
with hunting and fishing. Such soil cultivation has been termed 
" hoe-culture," and is to be distinguished from agriculture with 
the aid of domesticated animals found in a later stage of devel- 
opment. 

This kind of agriculture is found in its highest state of development among 
the Negroes of Africa. " The ground for cultivation," says Ratzel, "is cleared 
by means of fire, or with the hatchet or small ax. On the east coast a broad 
chopper with a spear-shaped blade and short handle is also used. The 
lance or spearhead has, in general, to serve many peaceful purposes. Larger 
trees are killed by barking. Thorny branches are placed as a border to the 
iields, under the shelter of which close, quick hedges gradually grow up. The 



THE EVOLUTION OF ECONOMIC SOCIETY 35 

ground is broken and cleared of weeds with a wooden spade sharpened to an 
edge at either end. Many peoples have hitherto not ventured to use iron 
tools, since they keep away the rain. When the ground has been got ready, 
somewhere about the beginning of the rainy season, the sower walks over 
the field, scraping a hole with his naked foot at every step, into which he lets 
some grains fall from his hand ; the foot covers them up, and if the good 
witch doctor makes rain enough, and the bad one does not keep it back, there 
is nothing more to be done until harvest, unless to hoe the weeds once. . . . 
To the present day the plow is practically strange to them." ^ 

The following characterization of the economy of primitive 
man applies with varying accuracy to the many tribes that may 
be placed in this first stage. 

Characteristics of Primitive Man. — The range of wants is 
narrow : the savage is generally satisfied if he obtains mere 
subsistence of the rudest sort. In the satisfaction of these 
few wants he is, according to our modern standards, remark- 
ably inefficient. From even the best natural resources he 
manages to get but a very poor living, depending as he does 
largely on the spontaneous products of nature. Magic and 
ritual are very generally relied upon as aids to wealth produc- 
tion. He is improvident, for he does not feel keenly the un- 
certainties of the future, and fails to make provision for them. 
Hence he has alternate periods of starvation and plenty. 
Only a small population is possible in this stage, as a tribe 
must have a large expanse of territory from which to draw its 
sustenance. The place of abode is easily changed, and warfare 
with neighboring tribes frequent. Private property in land is 
absent, although the beginning of the institution of ownership 
appears in the recognition of the individual's right to articles 
of personal use. There is little division of labor. What one 
man can do, all can do. The cultivation of the soil by the 
women and the specialized work of the medicine man are ex- 
ceptions. As each tribe produces or finds for itself all that it 
uses there is little or no trade. The beginnings of slavery are 
found, but this institution plays no important part in the 
economy of primitive man, except among the most advanced 
tribes. 

'Ratzel, History of Mankind, trans, by A. J. Butler, vol. ii, pp. 380-382. 



36 OUTLINES OF ECONOMICS 

II. The Pastoral Stage 

In the older accounts of economic evolution, the impression is 
given that hunting peoples learned to domesticate animals and 
then led a pastoral life, later learning to subdue the vegetable 
kingdom, thus becoming agriculturalists. This is not alto- 
gether accurate. It is possible that the domestication of 
animals was developed in regions where considerable progress 
had been made in hoe-culture. As this knowledge spread, 
certain tribes became and remained pastoral nomads in regions 
where agriculture was impossible. But whatever the actual 
steps may have been, the pastoral peoples represent a type of 
culture that is lower than that of the agricultural stage (as 
distinguished from hoe-culture), and higher than that of the 
hunter. Within this stage also are classed together tribes 
of varying advancement. Illustrations of existing pastoral life 
are found in the tribes of central Asia, many of the Arabian 
and African tribes, and the Todas of India. Attempts have 
been made to trace the pastoral stage in the early history of 
the Hebrews, Germans, Greeks, and Britons. 

Characteristics of Pastoral Peoples. — Some marked features 
of the first stage are found also among pastoral peoples. A 
fixed abode is not possible, as food must be found for the herds 
and flocks. Cities do not develop. Moreover, while the land 
will now support many more inhabitants per square mile than 
before, much land is still needed for pasture, and there is frequent 
collision and warfare between neighboring tribes. It follows 
also that there is very little private ownership of land among 
these peoples. Tribes as a whole lay claim to certain districts 
and try to keep other tribes from pasturing their flocks on 
them. In this stage there are frequently individual accumula- 
tions of wealth, consisting mostly of herds or flocks, and thus 
the contrast between rich and poor makes its appearance. Cus- 
tomary rules regarding the inheritance of wealth are recognized. 
But this early wealth does not produce commerce to any con- 
siderable extent, simply because there is little division of labor 
either between localities or within the tribe. 



THE EVOLUTION OF ECONOMIC SOCIETY 37 

III. The Agricultural Stage 

In this stage there is an enormous increase in man's power 
over nature. The production of wealth is increased especially 
by the use of animal power in cultivating the soil. One result 
is increased population. Land which under the more primitive 
methods of getting a living would give a scanty support to a 
small tribe for a part of the year will now maintain a whole 
community with a fixed abode. It is necessary for human 
development that men should live in definite places and have 
homes and a country. This results in new relations between 
men, new duties, new arts, and new possibilities. The beginning 
of the institution of private ownership in land falls within this 
stage, although it is difficult to trace the actual steps in the 
process. 

A most important characteristic of this period is slavery. 
Slavery begins long before improved agriculture, but it now 
attains its full magnitude as an institution. Slavery occupies 
a prominent place in the history of Greece and Rome, and in 
the Middle Ages develops into serfdom. 

Commercial intercourse is still comparatively slight in this 
stage. Fixed residence develops village communities, and 
these are economically self-sufficient. That is, they produce 
the things that they consume, and do not as a rule have surplus 
products to dispose of to others. Hence money does not at 
this time play an important part in the every-day life. The 
economic condition of Europe during the Middle Ages, before 
the growth of cities, illustrates the agricultural stage. 

The Manorial Economy in England. — England was almost 
wholly agricultural for three centuries following the Norman 
Conquest. In the thirteenth century the population for the 
most part lived in villages or manors, each controlled by a 
lord to whom the rest of the inhabitants were bound by custom- 
ary rules to render certain assistance, as in the cultivation 
of his land. The villagers were of various classes, according 
to the amount of land which they held and according to the 
services which they were required to perform. The land of 



^S OUTLINES OF ECONOMICS 

each tenant was not a compact area, but was composed of strips 
scattered in the three great fields into which the arable land was 
divided for purposes of crop rotation. 

Some handicraftsmen were also found upon the estate, but they do not 
occupy an important place in the economy of the village. For the most part, 
they were probably slaves or household servants. Slaves in England con- 
stituted at the time of the Conquest about nine per cent of the population, 
but "in some of the eastern and midland shires do not appear at all, or fall 
to a percentage of four or five," while they rise to as much as twenty-four 
per cent in other parts of the country. " We cannot but explain this ' by the 
supposition that in the later stages of the English conquest a greater number 
of the British cultivators were spared, so that in these districts slaves came to 
form a considerable part of the rural population. Absolute slavery, how- 
ever, disappeared in less than a century after the Conquest, and the servi 
became customary holders of small plots, like the cotters elsewhere, but on 
more onerous conditions." ^ 

These manors were largely self-sufficient in their economic life. 
There was, to be sure, some trade. England exported raw 
products to the continent and received back some of the finer 
forms of manufacture. But the ordinary needs of the very 
frugal life which the tenants had to live were supplied by prod- 
ucts of the manor itself. During the centuries following the 
Norman Conquest important changes took place in the manorial 
system : (i) a rapid growth in the number of free tenants ; 
(2) the commutation of customary services into fixed payments 
in money or kind ; and (3) the appearance of a class of agri- 
cultural laborers dependent on the wages which they received. 

In contrasting the manorial economy with the village of the 
present day, Professor W. J. Ashley has pointed out the follow- 
ing differences : (i) Now English farmers generally live in 
separate homesteads among the fields they rent, but then all the 
cultivators lived side by side in the village street. (2) Now 
each farmer follows his own judgment as to his agricultural 
operations, but in this early period he took his share in the 
common method of cultivation, which was regulated by custom, 
enforced by the manor courts. (3) Today, if the landlord 
himself engages in farming, his management is independent 

1 See Ashley, English Economic History, vol. i, pp. 17-18. 



THE EVOLUTION OF ECONOMIC SOCIETY 39 

of that of his tenants, but under the manorial system he de- 
pended almost exclusively upon the labor of his tenants, who 
contributed plows, oxen, and men. (4) Aside from the great 
gulf between lord and tenants., there was then no such social 
separation between the cultivators as there is today between 
large and small farmers. The manorial economy of England 
was a type, though somewhat more systematically developed, 
of conditions on the continent of Europe. 

IV. The Handicraft Stage 

This stage begins with the development of towns as centers 
of trade and handicraft in the latter part of the Middle Ages 
and extends to the introduction of power manufacture in the 
latter part of the eighteenth century. During such a long 
period many changes took place in the economic life of the 
people of Europe, but so far as the growth of man's power over 
nature is concerned the whole period is in marked contrast with 
the modern era of machine production. 

The Gild System. — The growth of trade brought with it the 
merchant gild, the purpose of which was to regulate the conduct 
of trade and to keep a monopoly of it for the merchants of the 
town. Merchant gilds appeared in all the larger towns of Eng- 
land in the twelfth century. But a new class was developing in 
the towns, — the craftsmen who were engaged in the making of 
things for sale. As this . handicraft grew in importance, the 
merchant gild was superseded by the craft gild, which in England 
attained its fullest development in the first half of the fourteenth 
century. Each craft had its gild, which specified in detail how 
the business should be carried on, how many should be admitted 
to it, and how the trade should be learned. This growth in spe- 
cialization meant also a growth in trade, but in this early part of 
the handicraft period, commerce was much restricted as com- 
pared with that of the present day. The towns made exchanges 
mostly with the country surrounding them, there being as 
yet no national or world market of any importance. Plainly 
such a general system of exchange could not be carried on by 
barter, and in this period money became increasingly important. 



V 



40 OUTLINES OF ECONOMICS 

The agricultural stage had in the greater part of Europe cul- 
minated in the feudal system. The nobility maintained order 
and attended to the fighting while the serfs tilled the soil. The 
manufacturing cities became the rivals of the feudal lords, who 
felt their power threatened, and hence they bitterly opposed 
the cities. The cities were free, and the serfs who fled to them 
were accepted and made freemen. 

The Domestic System. — With the beginning of the modern 
period the town system gave way to a larger economy. The 
towns lost the control of trade. The gild system was gradually 
succeeded by tlie domestic system, which developed in the 
sixteenth and seventeenth centuries and was a characteristic 
feature of English industry until the middle of the eighteenth 
century. As in the gild system, industry was carried on by 
hand in a small way, but the functions of merchant and workman 
were now separated. The gild master sold the goods which he 
produced in his shop directly to the customers who were to use 
the goods, but under the domestic system the workman came 
to be less independent. He received the raw material from a 
middleman, to whom he also delivered the finished product. 
Much of this work was done outside of the towns, the artisans 
thus being enabled to devote part of their time to agriculture. 
Defoe, in his tour through Great Britain (1724-1726), describes 
the methods employed as follows : 

The land "was divided into small inclosures from two acres to six or seven 
each, seldom more ; every three or four pieces of land had an house belonging 
to them, . . . hardly an house standing out of a speaking distance from 
another. . . . We could see at every house a tenter, and on almost every 
tenter a piece of cloth or kersie or shaloon. ... At every considerable 
house was a manufactury. . . . Every clothier keeps one horse, at least, 
to carry his manufactures to the market, and every one generally keeps a 
cow or two or more for his family. By this means the small pieces of in- 
closed land about each house are occupied, for they scarce sow corn enough 
to feed their poultry. . . . The houses are full of lusty fellows, some at the 
dye-vat, some at the looms, others dressing the cloths ; the women or chil- 
dren carding or spinning, being all employed, from the youngest to the oldest." 

Agricultural Changes. — Many important changes in the 
agriculture of England took place during the handicraft stage. 



THE EVOLUTION OF ECONOMIC SOCIETY 41 

The most prominent of these is the process called inclosure. 
Under the manorial system the lands in the common fields were 
the property of a landlord, but his rights were not exclusive 
and were qualified by rights of the tenants. There existed a 
certain kind of partnership of landlord and tenant in the culti- 
vation of the land. Inclosure is the term used to designate 
the dissolution of the partnership, or the separation of rights. 
After inclosure the tenant had generally a farm which was in 
one piece of land, instead of being in scattered strips in different 
fields, and for this he paid usually a definite money rent. The 
farmer could make improvements on his own account, which 
was impossible when he held scattered strips in great fields. 
Inclosures were made during this whole period and especially 
during the Tudor period. Farms became larger and when 
labor was scarce and wages high, sheep farming, requiring few 
laborers, was rapidly extended. Inclosures resulted in great 
agricultural improvement, but at the same time they were 
frequently attended with hardship for the poorer people. Some- 
times the common rights, especially those of common pasturage, 
were not fully paid for, although the rule was that of compensa- 
tion. But the result was to separate many people from the 
land; frequently the payment received by the poorer people 
was wasted. The right to pasture a cow meant a definite con- 
nection with the soil ; the money received in payment for this 
right might quickly disappear. Even now in English villages 
it is possible to find those who receive small sums for ancient 
rights, and these are too often used in dissipation. In Epworth, 
England, the villagers formerly had a right to cut turf in a field 
which is now let for a money rent, and this is used to buy coal 
which is distributed among the people in payment of their an- 
cient rights. 

Convertible husbandry, rotation of crops, the cultivation of 
root crops, improved breeds of animals and other forms of 
agricultural progress accompanied inclosure, which is still 
going forward, although the process is nearly completed so far 
as the arable land is concerned. A halt has now been called to 
the inclosure of forests and common fields, especially when used 



42 OUTLINES OF ECONOMICS 

for pasturage, and these are now found scattered over England 
and used as public parks and playgrounds ; but often with 
certain private rights of pasturage which have descended to 
their owners by inheritance or which have been acquired other- 
wise, as by the purchase of a cottage to which the rights are 
attached. An illustration of a village with extensive common 
fields is afforded today by Stelling Minnis, near Canterbury, 
England. 

The Mercantile System. — The decay of town authority did 
not mean that industry and commerce were left to the free play 
of competition. The supervision of the central government 
took the place of that of the towns. The national system of 
regulation has been called the Mercantile System, which pre- 
vailed in England (and in other countries) from the sixteenth 
century to the nineteenth. Its essential idea is the guidance of 
economic affairs in such a way as to increase the commercial 
and military power of the nation as a whole. The navigation 
laws which the student has met with in his study of American 
history were a part of this system. An attempt was made to 
create a " favorable " balance of trade and to maintain a good 
supply of the precious metals. Agriculture was fostered with 
the aim of promoting the growth of population. The mercantile 
system has" often been described as consisting chiefly of trade 
restrictions, but it is the contention of Professor Schmoller 
that in its essence the system meant " the replacing of a local 
and territorial economic policy by that of the national state." 

It was characteristic of the mercantile system, too, to interfere 
in the conduct of internal trade. Prices, wages, and the rules 
of apprenticeship were fixed by public authority. The quality 
of goods was inspected by public ofhcials. Patents of monopoly 
on the sale of certain commodities, such as gunpowder, matches, 
and playing cards, were extensively granted by royal authority 
to favored individuals or companies, ostensibly to foster new 
industries. 

"At the Council of York, Charles was obliged to declare many of the 
industrial patents void; but enough remained to call forth an indignant 
declamation from Sir. J. Colepepper in the Long Parhament: 'I have but 



THE EVOLUTION. OF ECONOMIC SOCIETY 43 

one Grievance more to offer unto you; but this one compriseth many; it 
is a nest of wasps, or swarm of vermin, which have overcrept the land, 
I mean the monopoler and polers of the people. These like the frogs of 
Egypt, have got possession of our dwellings, and we have scarce a room free 
from them ; they sip in our cup, they dip in our dish, they sit by our fire ; 
we find them in the dye- vat, wash-bowl, and powdery tub ; they share with 
the butler in his box, they have marked us and sealed us from head to foot. 
Mr. Speaker, they will not bate us a pin ; we may not buy our own cloaths 
without their brokage. These are the leeches that have sucked the com- 
monwealth so hard that it is almost become hectical. And some of these 
are ashamed of their right names; they have a vizard to hide the brand 
made by that good law in the last Parliament of King James ; they shelter 
themselves under the name of a corporation; they make bye-laws which 
serve their turns to squeeze us and to fill their purses ; unface these and they 
will prove as bad curs as any in the pack. These are not petty chapmen, but 
wholesale men.'" ^ 

A full account of this stage in English history would deal with 
(i) the regulation of labor, including the Statute of Artificers 
passed in the reign of Elizabeth, which provided that all able- 
bodied men might be compelled to serve as agricultural laborers, 
and that all artificers, rural or urban, should undergo an appren- 
ticeship of at least seven years. In this same reign provision was 
made for the assessment of wages by the Justices of the Peace. 
Every year in each locality the justices were to assemble, and, 
" calling to them such discreet and grave persons ... as they 
shall think meet, and conferring together respecting the plenty 
or scarcity of the time," they were to fix the wages for every 
kind of manual labor, skilled or unskilled, by the year, week, or 
day, and with or without allowance of food. A full account 
would deal also with : (2) the development of systematic poor 
relief by civil authority ; (3) the encouragement of shipping and 
of (4) the immigration of foreign artisans to introduce new in- 
dustries ; (5) the regulation of the corn trade ; (6) the establish- 
ing of plantations in the colonies ; (7) the regulation of the coin- 
age ; (8) the development of banking, insurance, and foreign 
commerce, and the decay of the old notions regarding the sinful- 
ness of interest taking. 

1 Cunningham, English Commerce and IiuJiislry. Modern Times, Part i, pp. 
307-308. 



44 OUTLINES OF ECONOMICS 

V. The Industrial Stage 

In the latter part of the eighteenth century, the slow-going 
methods of the handicraft stage were radically changed by the 
Industrial Revolution. The fundamental feature of this change 
is the introduction of power manufacture. The industrial revo- 
lution and the chief features of the industrial stage will be dis- 
cussed in the following chapter. 

Before proceeding to the consideration of the last stage, it 
will be well to notice some of the other views which have been 
expressed concerning the periods of economic development. The 
German economist, Hildebrand, has taken as his principle of 
classification the method of exchanging goods, and from this 
standpoint he gets the following three stages : (i) barter, (2) 
money, and (3) credit. All three methods of exchanging, to be 
sure, are in use at the present time, but the extensive use of 
credit is the new and characteristic thing about present-day 
exchange. It has been objected that the period before the use 
of money became prominent is characterized not so much by 
the barter of goods as by the fact that exchange itself is unim- 
portant. 

Another writer (Biicher) has divided economic history accord- 
ing to the nature and size of the normal self-sufficing economic 
unit, as follows : (i) the independent domestic economy, (2) the 
town economy, (3) the national economy. 

In the first stage the interval between production and 
consumption is small. Things are produced where they are 
consumed, as in the village communities of the early middle 
ages. In the town economy the interval is somewhat greater. 
The artisans in the town produce for the consumption of other 
persons, for the most part in the immediate neighborhood, so 
that the producer meets the consumer without intermediaries. 
In the third stage, production is for a national market, so that 
goods may pass through many hands before reaching the 
consumer, and the system of cooperative division of labor 
embraces the whole nation. Possibly, according to this view, a 
fourth stage might be added, — that of a nascent world economy. 



THE EVOLUTION OF ECONOMIC SOCIETY 



45 



Again, we might pay attention chiefly to the condition of 
labor. Beginning with a condition where there is no distinct 
laboring class, we pass through slavery and serfdom to free 
labor, regulated at first by law and custom, then by individual 
contract, and finally in large measure by group contract or col- 
lective bargaining supplemented to an increasing extent by 
legal regulations of a new kind. 

THE ECONOMIC STAGES 



From the 
Standpoint 
OF Produc- 
tion 


From 
Bucher's 
Standpoint 


From 
Hildebrand's 
Standpoint 


From 
THE Labor 
Standpoint 


Illustrations 
FROM English 
History 


I. 

Direct Ap- 
propriation 


Independent 
Domestic 
Economy 


Barter 
Economy 


Laboring 
class not dif- 
ferentiated 


Prehistoric 


2. 

Pastoral 


Before Christ 


3- 
Agricultural 


Slavery and 
Serfdom 


nth- 1 4th 
Centuries 


4- 
Handicraft 


Town 
Economy 


Money 
Economy 


Free Labor 
governed 
by Custom 


i3th-i8th 
Centuries 


5- 
Industrial 


National 
Economy 


Credit 
Economy 


Individual 
Contract 

Group 
Contract 


1 8th Century 
to the Pres- 
ent Time 



These various classifications are not contradictory ; on the 
contrary, they supplement each other. Still other divisions 
are possible. In the preceding table these various points of 
view are roughly correlated and applied to the history of 
England. These divisions of time are in no sense accurate, and 
are intended merely to be suggestive. 



4.6 OUTLINES OF ECONOMICS 

QUESTIONS AND EXERCISES 

1 . Write a description of the economic life of a tribe in one of the first two 
stages. 

2. What is the diiierence between slavery and serfdom? 

3. Give an account of the East India Company. 

4. Sketch the development of the woolen industry in England to 1 760. 

5. Give an account of the origin of the Bank of England. 

6. Summarize the history of poor relief in England. 

7. It has been held that because economic progress has been continuous, 
it is incorrect to divide it into "stages. " Discuss this view. 

REFERENCES 

Ashley, W. J. English Economic History, Vol. i; and The Economic Or- 
ganization of England, Chaps, i-v. 

BiJCHER, Karl. Industrial Evolution (trans, by S. M. Wickett). 

Cheyney, E. p. Industrial and Social History of England, Chaps, i to vii. 

Cunningham, William. Growth of English Industry and Commerce, Vol. i. 
(Middle Ages) and Vol. ii (Mercantile System). 

Ely, R. T. Evolution of Industrial Society, Part i, Chap. iii. 

Conner, E. C. K. Common Land and Inclosure. 

Hone, N. J. The Manor and Manorial Records. 

LiPSON, Ephraim. An Introduction to the Economic History of Englattd, 
Vol. i. 

Meredith, H. O. Outlines of the Economic History of England. 

Morgan, L. H. Ancient Society, Chap. i. 

Prothero, R. E. English Farming, Past and Present, Chaps, iii, iv,'vii, xi. 

Ratzel, Friedrich. History of Mankind (trans, by A. J. Butler), 3 vols. 

Salzmann, L. F. English Industries of the Middle Ages. 

ScHMOLLER, GusT.AV. The Mercantile System (Economic Classics, edited by 
W. J. Ashley). 

Seebohm, Frederic. The English Village Community. 

Stanley, H. M. In Darkest Africa, Vol. i, Chap, xxiii. 

Unwin, George. The Guilds and Companies of London. 

Vinogradoff, Paul. The Growth of the Manor. 

Wallace, A. R. Russia (edition of 1905), Chap. viii. 



771.: 

CHAPTER IV 
THE EVOLUTION OF ECONOMIC SOCIETY {Continued) 

The Industrial Revolution. — The passage from the handi- 
craft to the industrial stage in England is generally known as 
the Industrial Revolution. It has been objected that this 
term is misleading because the introduction of the modern fac- 
tory system required many years and was but the working out 
of conditions that had been long maturing. It is true that the 
growth in the division of labor, the expansion of commerce, and 
the technical progress of f ermer ages were necessary preliminaries 
to the industrial revolution, but there is little danger of over- 
emphasizing the importance or the rapidity of the change. 
The period from 1770 to 1840, the span of a single life, is, after 
all, a short period from the standpoint of the historian. Yet 
the changes of this period swept away the inefficient methods 
that had been used for centuries, and caused profound modifi- 
cations in social structure. To understand the nature of this 
movement, we must review the condition of things before it 
began. 

England in 1760. — England was at this time largely self- 
sufficing in its economic life, producing for itself its food and other 
articles of ordinary consumption, although compared with medi- 
eval days there had been a marked expansion of international 
and colonial trade. Woolen goods were the most important ex- 
port. The imports consisted largely of wines, spirits, rice, 
sugar, coffee, oil, and furs, and some wool, hemp, silk, and linen 
yarn. Within the nation, too, there was not such a degree of 
specialization of industry in particular localities as is found at 
the present day, although the beginning of such localization had 
clearly been made in the textile and iron industries. On the 
whole, however, the commerce between the different sections 

47 



48 OUTLINES OF ECONOMICS 

of the country was slight. The means of transportation were 
exceedingly poor, notwithstanding the growth of turnpike roads. 
The roads were described by a traveler as " most execrably 
vile." Such was their condition that pack horses were still a 
common means of getting goods to market. Rivers were im- 
portant highways, canal building having barely begun. 

The system of hand manufacture was still in general opera- 
tion. Although the workmen under the domestic system were 
no longer owners of the material upon which they worked, yet 
the tools they used were their property. The beginnings of 
certain features of the factory system, however, are to be seen 
long before the use of power machinery, for in some cases work- 
men were employed in large numbers in buildings owned by 
the employer, who also furnished the mechanical equipment. 
But to a large extent manufacturing was combined with agri- 
culture, not only in the textile trad^, but in other branches 
also. " At West Bromwich, a chief center of the metal trade, 
agriculture was still carried on as a subsidiary pursuit by the 
metal workers." 

The medieval system of common field tillage was extensively 
used, a large part of the land being still uninclosed. The culti- 
vation was exceedingly poor, but important experiments tend- 
ing toward a '' new agriculture " were being made in the second 
quarter of the eighteenth century by Jethro Tull and " Turnip " 
Townshend. Of the whole number of farms, approximately 
one half " were owned and occupied by the various classes of 
freeholders and copyholders; that is, by land-owning farmers." 

The medieval notion of the relation of government to in- 
dustry was still nominally in force. Detailed and special 
legislation was supposed to be the means of securing a well- 
ordered trade, as explained in the preceding chapter. But a 
tremendous revolt had begun against this whole system. This 
revolt had its religious and political as well as its economic 
aspect. The same year that Thomas Jefferson wrote the Dec- 
laration of Independence, asserting that all men are by nature 
equal, Adam Smith published the Wealth of Nations, the most 
influential book ever written on economics. 



THE EVOLUTION OF ECONOMIC SOCIETY 49 

"Every individual," said Smith, "is continually exerting himself to find 
out the most advantageous employment for whatever capital he can com- 
mand. It is his own advantage, indeed, and not that of the society, which 
he has in view. But the study of his own advantage, naturally, or rather 
necessarily, leads him to prefer that employment which is most advantageous 
to society. . . . What is the species of domestic industry which his capital 
can employ, and of which the produce is likely to be of the greatest value, 
every individual, it is evident, can, in his local situation, judge much better 
than any statesman or lawgiver can for him." ^ 

The Mechanical Inventions. — During the last half of the 
eighteenth century the progress of invention was exceptionally 
rapid. Kay's flying shuttle (1738) had facilitated the weaving 
process to such an extent that it became difficult to secure 
enough yarn from the spinners. Hand spinning was improved 
by Hargreave's "jenny" about 1767; Arkwright, in 1771, 
made a practical success of roller spinning (a method patented 
long before) , using horse power, and later, water power. Cromp- 
ton combined these two processes in 1779. After 1785 steam 
power was applied to cotton spinning, and then it was the weav- 
ing process that was felt to be too slow. Cartwright began his 
experiments in 1784, but the power loom did not come into 
general use until early in the nineteenth century. 

The improvement in the steam engine also made possible 
great advances in the iron industry, of fundamental importance 
in an age of machinery. The production of English iron was 
over seventy -five times as great in 1840 as it had been in 1740. 

The need for better transportation was met by improved 
roads, by the building of canals (especially 1790 to 1805), and 
by the development of steam locomotion. The germ of the 
modern railway is seen in the tramways used in the coal mines. 
Cast iron rails were used as early as 1738. The first tramway 
to be used for public purposes was chartered in 1801, the cars 
to be drawn by horse power. Trevithick made a locomotive 
in '1803 that was of practical use. In 1814 Stephenson con- 
structed a locomotive that could draw a load of thirty tons at 
the rate of three miles an hour. The Stockton and Darlington 
road was opened in 1825 with a Stephenson locomotive that 

1 A. Smith, Wealth of Nations, Book iv, Chap. ii. 
E 



50 OUTLINES OF ECONOMICS 

made fifteen miles an hour, but two years later the directors of 
the road considered the advisability of abandoning the use of 
locomotives. In 1829 the directors of the Liverpool and Man- 
chester Railroad arranged a prize contest to determine the 
practicability of steam locomotion. The success of Stephenson's 
" Rocket " in meeting the requirements of the contest demon- 
strated that the new method of locomotion had come to stay. 

"A general survey of the growth of new industrial methods in the textile 
and iron industries marks out three periods of abnormal activity in the evolu- 
tion of modern industry. The first is 1 780-1 795, when the fruits of early 
inventions were ripened by the effective application of steam to the machine 
industries. The second is 1830 to 1845, when industry, reviving after the 
European strife, utilized more widely the new inventions, and expanded 
under the stimulus of steam locomotion. The third is 1856-1866 (circa), 
when the construction of machinery by machinery became the settled rule 
of industry." ^ 

Agricultural Changes. — During the Industrial Revolution 
there were also important changes in agriculture. Bakewell, 
in the second half of the eighteenth century, improved the breeds 
of sheep and cattle. The inclosing of the common fields pro- 
ceeded with great rapidity, not, as in the sixteenth century, for 
the purpose of sheep raising, but to permit of more efficient 
tillage of the soil. Between 1760 and 1850 over seven million 
acres were inclosed in England. The small land-owning farmer 
was crowded out, partly because more investment per acre was 
needed with the new agriculture, partly because " gentlemen 
farmers " (men who had made money in other pursuits and took 
up agriculture because it was fashionable) bought them out, 
and because the price of land was greatly increased by the desire 
of wealthy men to build up family estates. Today practically 
all English farmers are tenants. The small farmer, who under 
the domestic system was also frequently a handicraftsman, was 
thus crushed between the new agriculture and the new industry. 

"Hitherto the rude implements required for the cultivation of the soil, 
or the household utensils needed for the comfort of daily life, had been made 
at home. The farmer, his sons, and Iiis servants in the long winter evenings 

' Hobson, Evolution of Modern Capitalism, cililion of 1907, p. 89. 



THE EVOLUTION OF ECONOMIC SOCIETY 51 

carved the wooden spoons, the platters, and the beechen bowls, plaited wicker 
baskets, fitted handles to the tools, cut willow teeth for rakes and harrows 
and hardened them in the fire, fashioned ox yokes and forks, twisted willows 
into the traces of other harness gear. Traveling carpenters visited farm- 
houses at rare intervals to perform those parts of work which needed their 
professional skill. The women plaited the straw for the neck collars, stitched 
and stuffed sheepskin bags for the cart saddle, wove the straw and hempen 
stirrups and halters, peeled the rushes for and made the candles. The 
spinning wheel, the distaff, and the needle were never idle ; coarse hand-made 
cloth and linen supplied all wants ; every farmhouse had its brass brewery 
kettle. . . . All the domestic industries by which cultivators of the soil 
increased their incomes, or escaped the necessity of selling their produce, 
were now supplanted by manufactures." ^ 

Effects of the Industrial Revolution. — As has already been 
indicated, the Industrial Revolution introduces one of the great 
stages in the development of man's power over nature. But 
along with the new opportunities came also new dangers and 
perplexing problems. 

I. The Factory System. — The use of expensive machinery 
and steam power made it impossible for men to carry on their 
work in their own homes. The factory supplanted the home as 
the typical center of production. Instead of working by them- 
selves or with a few assistants, men now to a much greater 
extent than before had to congregate in cities, and submit to a 
new discipline in large groups organized for purposes of pro- 
duction. This brought with it a new division of society into 
classes. The machine and the workshop, as well as the raw 
material and the product, are at no stage in the productive 
process owned by the men who do the manual work. The 
masses become wage earners. Now, in some industries not one 
in a hundred can by exceptional ability become an independent 
employer, and the workman knows that he is a workman for 
life. So we have now two industrial classes, laborers and 
capitalists, with a great gulf between them which comparatively 
few men can cross, and with interests which often seem irrec- 
oncilable. What the ultimate effects of the new system of 

' Prothero, quoted by Curtningham, Growth of English Industry and Commerce, 
Modern Times, Part ii, p. 722. 



52 OUTLINES OF ECONOMICS 

production will be cannot be stated, but it has been suggested 
that these changes in external relations are affecting also men's 
habits of thought. Can we expect the institution of private 
property to seem as natural and sacred to those who have 
nothing to do with the buying and selling of products as to those 
who engage much in pecuniary transactions? It has been 
suggested that the feeling that we have a right to the product 
of our own labor is merely a survival of the era of small-scale 
hand manufacture. 

2. The Expansion of Markets and Industrial Specialization. — 
Along with the new methods of production there has been a 
change from restricted local markets to national and even world 
markets. Improved methods of transportation make it possible 
for different branches of production to be localized in regions 
where there are special facilities for raw material or power. This 
implies greater economic interdependence and greater liability 
to trade fluctuations and disturbances. One great advantage 
of the old slow-going system of manufacture and trade was its 
regularity. As the area of the market increases, manufacturers 
find it more difficult to decide what and how much to produce. 
Trade fluctuations have increased in severity with the growth 
of large-scale production. This is due not merely to the chang- 
ing and enlarging demand which cannot be calculated, but also 
to the fact that manufacture itself is constantly being disturbed 
by improvements which cannot be foreseen. It is possible 
that a still larger scale of manufacture hereafter will bring steadi- 
ness in industry, but whatever the cause of these fluctuations, 
the effect upon the wage earner is demoralizing. If he were 
wise enough to save his earnings during good times, and so have 
something for hard times, he would not suffer so much. But 
very few people who live in abundance can do this ; how much 
less those whose condition even in good times is one of meager 
comfort ! 

Evils of the Transitional Period. — The condition of the 
English working classes in the latter part of the eighteenth and 
early nineteenth centuries was undoubtedly worse than in any 
other period in the history of the country. It is difficult to 



THE EVOLUTION OF ECONOMIC SOCIETY 53 

say to what extent this was due to the introduction of the fac- 
tory system. In addition to the new methods of manufacture 
there were wars, peculiar conditions in land ownership, duties, 
and taxes. There is some evidence that the condition of child 
workers under the domestic system was often worse than in 
the factories, their parents proving the hardest taskmasters. 

"The evils and horrors of the industrial revolution are often vaguely- 
ascribed to the ' transition stage ' brought about by the development of ma- 
chinery and the consequent 'upheaval.' But the more we look into the 
matter, the more convinced we become that the factory system and machin- 
ery merely took what they found, and that the lines on which the industrial 
revolution actually worked itself out cannot be explained by the progress of 
material civiKzation alone ; rather, the disregard of child-life, the greed of 
child-labour, and the maladministration of the poor law had, during the 
eighteenth century, and probably much farther back still, been preparing 
the human material that was to be so mercilessly exploited." ^ 

But whatever the causes, the facts that have been revealed re- 
garding the conditions in English mines and factories of this 
period are amazing. The picture includes cruelty to appren- 
tice children, excessive hours, and unhealthful conditions of 
work. The evils were worst in the smaller factories, the 
owners of which were hard pressed by relentless competition. 
Outside of the factories, also, those who attempted to continue 
to work in their homes in the old way suffered from irregular 
employment and low earnings. The distress of the hand-loom 
weavers affords an illustration. 

Competition and Laissez-faire. -;— We have seen that Adam 
Smith advocated liberty. He asserted that every man, if 
allowed to do as he pleased, would sooner or later do that for 
which he was best fitted, and would consequently work where 
he could get the most wages. Every man would buy what 
suited him best, and, after some experiments, manufacturers 
would make what was called for. If one line of work was more 
profitable than another, more men would go into it and by their 
competition would bring prices down. If men cheated their 
customers, the customers would go elsewhere, and cheating 

* Hutchins and Harrison, A History of Factory Legislation, p. 13. 



J 



54 OUTLINES OF ECONOMICS 

would not pay. Everywhere men would look out for their 
own interests and would make the bargain that was most ad- 
vantageous to themselves. This system of balanced self- 
interests resulting from competition was the best regulator 
possible, infinitely better, he claimed, than the old-time laws, 
which only incumbered the development of industry. If the 
policy of industrial freedom were adopted, there would be, he 
prophesied, a great increase in the production of wealth. 

This view gained favor during the Industrial Revolution. 
Not that a wholesale repeal of the old laws occurred — such things 
never happen in England, and are difficult anywhere — but 
there is a quiet and effective way of changing laws by changing 
men's ideas regarding them and leaving them unenforced. 
A law that has been long observed has often to be long dead 
before people gain the courage to repeal it. So the law requiring 
seven years' apprenticeship before one could enter certain 
trades quietly died during the eighteenth century, and when, 
finally, in the labor troubles early in the nineteenth century 
some workmen discovered the old law and prosecuted employers 
for violating it, it was first suspended and then repealed, as being 
plainly ill adapted to the new condition of industry. So, little 
by little, the old laws were repealed or forgotten, and men were 
left free to bargain and manufacture as they pleased. 

This policy of laissez-faire, or letting things drift, was very 
generally accepted by the economic writers who followed Adam 
Smith, and was clearly reflected in the parliamentary debates. 
The universal free play of -competition came to be the pre- 
vailing ideal in this first phase of the industrial stage. It was 
in keeping with this spirit that England became a free-trade 
nation in this period, the last step being taken when the " corn 
laws " were repealed in 1846, the act going into effect in 1849. 

The Reaction against the Passive Policy. — It may be said 
that by 1850 the abandonment of mercantilistic ideas was com- 
plete in England, but long before this date a new system of 
legislation for the purpose of controlling industry had been 
begun. The government could not ignore the actual condi- 
tions that resulted from competition and the introduction of 



THE EVOLUTION OF ECONOMIC SOCIETY 55 

machinery. We have now to consider some of the main lines 
of development of this modern industrial regulation. 

1. The Quality of Goods. — In repealing the laws for the in- 
spection of wares it was urged that cheating would not pay 
and would cure itself. Indeed, it was said that the very in- 
spection of wares by the government was the cause of fraud ; 
for, the government brand being often put on carelessly, men 
bought poor goods, because of the brand, which they would 
have rejected if they had examined them. The abolition of 
the laws would result in each examining goods for himself, it 
was asserted. It is hardly necessary to say that these hopes 
were not realized. Men might be trusted to attend to their own 
interests if they knew enough to do so, but they do not. Who 
can tell the quality of baking powder, or ground spices, or 
patent medicines, or many other things that are misrepresented 
when offered for sale? For these the ordinary buyer's knowl- 
edge is worthless ; an expert must be employed. Such has 
bepn the experience of the English people and also, more re- 
cently, of the people of the United States, and the law now pro- 
vides for the inspection by government experts of many articles 
of food. The notion that men will always ruin their business 
prospects if they cheat, and so will be deterred from cheating, 
has been utterly exploded by this English experiment. The rep- 
utation for honesty is undoubtedly a source of strength to 
many business houses; but many a man has perpetrated an 
audacious fraud upon a country for a few years and retired 
with a fortune when his cheating began to be known. The 
inspection of goods by the State is a principle now fully rec- 
ognized, the only question being how far it should be applied. 

2. The Protection of Labor. — As a result of a series of epi- 
demics of infectious fevers, public attention was called to the 
condition of the apprenticed children in cotton factories. In 
1796 the Manchester Board of Health reported upon the un- 
healthful conditions under which the children worked, pointing 
out that " the untimely labour of the night, and the protracted 
labour of the day, with respect to children, not only tends to 
diminish future expectations as to the general sum of life and 



56 OUTLINES OF ECONOMICS 

industry by impairing the strength and destroying the vital 
stamina of the rising generation, but it too often gives encourage- 
ment to idleness, extravagance, and profligacy in the parents, 
who, contrary to the order of nature, subsist by the oppression 
of their offspring." In 1802 the first factory act was passed to 
protect the health and morals of pauper children in cotton 
factories. The apprentices were not to work more than twelve 
hours by day, and after 1804 not at all by night, but the law 
was not effectively administered. After much agitation, in 
which Robert Owen took a prominent part, a second step was 
taken in 181 9. The act prohibited children under nine years 
from working in cotton mills, and no person under sixteen 
was to be employed more than twelve hours per day. As with 
the act of 1802, the enforcement of the law was left to the justices 
of the peace. In 1833 regulations as to conditions of work for 
children and young persons were made for all textile factories, 
and special inspectors were provided to enforce the law. In 
the following years the controversy concerning labor legislation 
was violent and bitter. After a report by a committee revealing 
shameful conditions in the mines, an act was passed in 1842 
prohibiting the employment of women and children under- 
ground. In 1844 women were included in the protective fac- 
tory legislation and the half-time system for children was 
enacted. The Ten Hours' Act of 1847 limited the working 
day to ten hours. Subsequently protective legislation was 
made to cover industrial establishments generally. These 
various laws were consolidated in 1878, and again in 1901. 

Another important line of legislation that has been made 
necessary by the extensive use of machinery deals with the 
liability of employers in cases of accidents to their workmen. 
Under the common law a workman was entitled to receive dam- 
ages when injured as a result of the negligence of his employers, 
but he was supposed to assume the ordinary risks of the busi- 
ness. When the injury was caused by the workman's own negli- 
gence or by the negligence of a fellow-workman the employer 
was not responsible. The Employers' Liability Act of 1880 
gave the workman the right to compensation in certain cases 



THE EVOLUTION OF ECONOMIC SOCIETY 57 

where the injury was caused by the negligence of other em- 
ployees, and in 1897, by the Workmen's Com'pensation Act, a 
radical departure was made from previous legislation. The 
employer is now liable to pay damages even when there has 
been no negligence on his own part, and even when the accident 
has been due to the neglect of the injured workman himself, 
except only in cases of " serious and willful misconduct." This 
principle now applies also to agriculture, shipping, and mer- 
cantile and domestic employments, and certain trade diseases 
have been made to count as accidents. The transition from 
"employers' liability" to "workmen's compensation" was thus 
a change in more than mere name. The law of employers' 
liability aimed merely at doing justice as between the workman 
and his employer. Workmen's compensation statutes are 
based upon a broader social principle, involving the recognition 
of the facts that industrial accidents are part of the price that 
has to be paid for the use of modern methods of production; 
that the worker and his family are ill-equipped to bear the burden 
of the loss of earning-power that results from such accidents ; 
and that the duty of making adequate compensation falls upon 
society at large, which may very properly use the employer 
as its responsible agent for this purpose. 

A newer and larger development of the principle of compensa- 
tion is found in social insurance, which recognizes and extends 
the principle of social responsibility, but combines with it an 
insistence upon the equal importance of the development of 
habits of individual thrift and self-help. The National In- 
surance Act of 191 1 provided for compulsory insurance against 
sickness, and (in certain industries) against unemployment. 

3. Labor Organizations. — Modifications in the working of free 
competition have also been effected by the voluntary organiza- 
tions of the workers, not only by their influence upon legislation, 
but also by direct dealings with employers. We have noticed 
the gilds, which played a large part in the history of the Middle 
Ages. These, however, were not like modern trades unions. 
They were unions of men who worked, but not exclusively of 
wage earners, nor even chiefly in the interests of wage earners. 



58 OUTLINES OF ECONOMICS 

They were formed of masters. But combinations of the wage- 
earning classes are found long before the Industrial Revolution. 
They do not become prominent, however, until the nineteenth' 
century. Laws prohibiting the combination of laborers had 
been passed at intervals since the Middle Ages, and in 1800 
Parliament, finding that unions were increasing, passed a most 
comprehensive law to suppress them, declaring illegal " all 
agreements between journeymen and workmen for obtaining 
advances of wages, reductions of hours of labor, or any other 
changes in the conditions of work." Under this law many 
workmen were prosecuted and severely punished, but in vain. 
In 1824 Parliament confessed the law a mistake, and repealed 
it along with previous laws relating to combinations of work- 
men. Trades unions, thus tolerated, grew at an astonishing 
rate, but they were still subject to legal persecution. Judicial 
decisions, especially, were adverse to them, as the courts re- 
garded them as agreements in restraint of trade. But in 1871 
a law was passed which declared that the purposes and actions 
of trades unions were not to be deemed unlawful as being in the 
restraint of trade, and in 1875 the legality of trades unions was 
still further recognized by the provision that acts which were 
not punishable as crimes when done by one person should not 
be indictable as conspiracy when done by two or more in further- 
ance of trade disputes, and finally, in igo6, the courts were 
forbidden to entertain actions for damages against trades unions. 
In this same year peaceful picketing was legalized. 

4. The Extension of Government Enterprise. — The reaction 
against a laissez-faire policy is further shown by a growth in the 
sphere of industry directly managed by the government. We 
find municipalities operating street railways and furnishing 
water, gas, and electric light. Municipal enterprise includes 
also in various places markets, docks, dwellings, baths, race 
courses, oyster fisheries, slaughterhouses, milk depots, employ- 
ment bureaus, sewage farms, theaters, and many other lines of 
activity. The national government conducts the postal sav- 
ings banks, the parcels post, and the telegraph and telephone 
systems. 



THE EVOLUTION OF ECONOMIC SOCIETY 59 

Summary. — In this chapter a brief sketch has been given of 
England's attempt to deal with a new set of forces. An im- 
mense increase in production has taken place, due in part to 
competition, more to machinery. But the distribution of this 
wealth, growing directly out of the principles of competition so 
long as they were unrestrictedly applied, was such that poverty 
grew rapidly, and some said even faster than wealth, and the 
laboring population of the realm sank into deeper distress and 
degradation. The partial benevolence of employers, which 
would fain have mitigated this disaster, was, as a rule, neither 
welcome nor tolerated by the competition which had made itself 
law. Not until this benevolence was formulated, generalized, 
and enforced by disinterested legislation was the horror of the 
sit,uation diminished. When we hear the principle of " a fair 
field and no favor " and " no State intervention " advocated by 
a man strong in the consciousness of personal advantages, we 
must remember that he is a century behind his time, and that 
he has not read or has not profited by one of the most dolorous 
chapters in human history. The English nation, after a trial 
of free competition and no interference, as thorough as could 
well be made, has undeniably returned to the principle of govern- 
mental activity which she had abandoned, — a principle which 
recognizes as the function of the State the protection of the 
citizens, and the furtherance of their material and social well- 
being, by every law and every activity which offers a reasonable 
guarantee of contributing to that end. It is to be noticed fur- 
thermore that, as a matter of fact all this activity of the State 
contributing to material and social well-being has also increased 
freedom as a positive, constructive force. It has promoted 
the growth of individual powers and enlarged the scope of activity 
of the average citizen. It has not tended to slavery, as Herbert 
Spencer long ago maintained, but its tendency has been in the 
direction of the sort of liberty that is really worth while ; namely, 
liberty as a power of development and of contributing (in the 
words of the philosopher T. H. Green) to the " common good." 
The older legislation restricted the individual ; the newer legis- 
lation enlarges and equalizes opportunities. 



6o OUTLINES OF ECONOMICS 

QUESTIONS AND EXERCISES 

1. What is the origin of the term "laissez-faire"? 

2. What laws are in force in your state regarding the inspection of food 
and other articles offered for sale? 

3. Give a detailed account of the development of one of the great inven- 
tions. 

4. Give a sketch of the enactment and repeal of the "corn laws." 

5. Give an account of the development of monopolies and trusts in 
England. 

REFERENCES 

Ashley, W. J. Economic Organization of England, Chaps, vii and viii. 

Beard, C. A. The Industrial Revolution. 

Cheyney, E. p. Industrial and Social History of England, Chaps, viii 
and ix. 

Cunningham, William. Growth of English Industry and Coinmerce, Mod- 
ern Times, Part ii, Laissez-Faire. 

Day, Clive. History of Commerce, Part iii. 

HoBSON, J. A. Evolution of Modern Capitalism, Chaps, iii and iv. 

HuTCHiNs, B. L., and Harrison, A. A History of Factory Legislation, 
Chap. ii. 

Perris, G. H. The Industrial History of Modern England. 

Slater, Gilbert. The Making of Modern England; The English Peasantry 
and the Enclosure of Common Fields. 

Toynbee, Arnold. The Industrial Revolution. 

Veblen, Thorstein. The Instinct of Workmanship, Chaps, vi and vii. 

Warner, G. T. Landmarks in English Industrial History. 



CHAPTER V 

THE ECONOMIC DEVELOPMENT OF THE UNITED 

STATES 

Economic Stages in American Industrial History. — The 

transit of civilization from Europe to America, as an American 
historian ^ has finely phrased it, thrust the European laws, 
customs, and industrial technique of the seventeenth century 
into the primitive environment of a wilderness, and for the 
moment the wilderness dominated. Industry was forced to 
begin at the beginning and retrace — as the child is said to 
retrace the mental development of mankind — the industrial 
evolution of the race. 

The American people have thus, during the comparatively 
brief historical period which has elapsed since the settlement 
of this country, run the whole gamut of industrial evolution, 
passing with striking rapidity through all the stages differen- 
tiated in the preceding chapters. There was slaughter of cap- 
tives in the Indian wars, enslavement of Indians, particularly 
— but not only — in the Spanish colonies, later the introduction 
of negro slavery and modified serfdom in the indentured servants, 
then the individual wage contract, still supreme among agri- 
cultural laborers, and finally, collective bargaining through 
the great trades unions of the present. In a similar way, 
practically all the stages differentiated in the table given on 
page 45 may be traced in the industrial evolution of the United 
States. 

Naturally it is not to be supposed that American industrial 
society worked its own way unaided through all those economic 
stages which the race, with " painful steps and slow," has labori- 
ously traversed in its upward march. Stimulated by European 

• Edward Eggleston, Transit of CiviUzalion. 
6i 



62 OUTLINES OF ECONOMICS 

culture, we hurried through the earher stages, for the most 
part, retracing them merely as an incident of frontier conditions, 
and skipping some — such as the pastoral stage — in many 
sections of the country. On the other hand, it must not be 
inferred that we have everywhere passed beyond the so-called 
primitive stages. Barter may still be found in some parts of 
the country, and there are comparatively few rural districts 
in which credit transactions have in the main taken the pilace 
of money transactions. It is interesting to observe that, owing 
to the progressive western movement of the population of 
the country, the stages in the history of man's productive efforts 
appeared in regular order from west to east. Thus, a few 
years ago, the country of the frontier was occupied by hunters 
and trappers; next were great stretches of country almost 
entirely devoted to grazing; farther east, agriculture pre- 
dominated ; trade and commerce were active, especially in the 
country east of the Mississippi ; manufacture on a large scale 
was prominent in the North Atlantic and North Central groups 
of states ; while finally the large industrial combinations which 
mark the latest step in development were confined (with respect 
to legal residence at least) to the Atlantic seaboard. " The 
United States lies like a huge page in the history of society."^ 
Sectionalism. — This phenomenon of the contemporaneous 
existence of several industrial stages, side by side, under the 
same government, has laid upon this country some of the hardest 
problems which it has had to solve. The ever present but 
ever receding frontier has continually created a set of interests 
antagonistic to those of the settled industrial and commercial 
communities. Shays's RebeUion in 1786 was in part a protest 
of the more thinly settled debtor communities against the deter- 
mination of the commercial centers to introduce the sound 
currency which a developed commerce requires. The federal 
Constitution was adopted and the present government created 
in order, largely, to strengthen national credit, insure taxation, 
remove trade barriers, and provide a sound currency ; and the 
opposition to the ratification of the Constitution came largely 
1 F. J. Turner, The Significance of the Frontier in American History. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 63 

from those agricultural and thinly settled communities that 
wanted to keep paper money, evade debt payment, and resist 
the collection of taxes. During the earlier history of the coun- 
try wildcat banking and inflated currency regularly followed in 
the wake of the frontier. 

Tariff legislation, with its different appeal to the agricultural 
and industrial sections of the country, has been another prolific 
source of territorial conflict. After the War of 181 2, the manu- 
facturing centers of the North redoubled their efforts for pro- 
tection. This was strenuously resisted by the South, where 
manufactures had practically gained no hold, and the struggle 
of the sections over the tariff led to Nullification in South Caro- 
lina and the acceptance by the South of the doctrine of secession. 
The Civil War itself was largely a sectional quarrel growing out 
of ceaseless friction between a section which had reached the 
industrial stage and a condition of free-wage contract with a 
section which had been held in the agricultural stage by the 
retention of slavery. As a more recent illustration of sectional 
conflict arising from the natural clash of districts in different 
stages of economic development, we have the free-silver cam- 
paign of 1896, when the mining, agricultural, and debtor com- 
munities of the West and South arrayed themselves against the 
industrial and creditor communities of the East and North. 
The typical political struggles of the past have been territorial, 
and sectional problems will always remain. Now that the 
frontier has disappeared, however, the typical political struggles 
of the future will take the form, probably, of class against class. 

Characteristics of the American People. — Although the 
frontier has disappeared, the pioneer work of " winning a con- 
tinent from nature and subduing it to the uses of man " has 
left an indelible impress upon the American character. In the 
beginning the dangers and hardships of the frontier acted as a 
powerful selective force in determining the character of our 
earlier immigrants, giving us an unusually restless, mobile, and 
enterprising people. The process of settlement which followed 
merely emphasized these qualities and added others of a kindred 
nature. The primitive settler, following the trapper and the 



> 



64 OUTLINES OF ECONOMICS 

trader into the wilderness, was forced to depend upon himself 
for protection and subsistence ; he expected little aid from the 
government, was unused to the restraints of law, and a little 
contemptuous of its possibilities, either for good or for evil. 
The process of settlement, then, merely confirmed the American 
in that excessive individualism which has made him independent 
and resourceful, to be sure, but partial to the spoils system, 
tolerant of lynch law and labor violence, indifferent to waste 
and weakness in the administration of his government. 

At the same time the great natural wealth of our land and the 
ease with which it could be secured from the government have 
taught our people, particularly in the West, to regard nature 
rather than thrift as the source of wealth, to exploit rather than 
create, to work and study as we farm, — extensively. As a 
people, we are optimistic but careless, generous but wasteful, 
buoyant but boastful. Industrially, we have risen to our ex- 
ceptional opportunities with spirit, playing the commercial game 
at times with excessive energy and devotion ; but we have come 
to emphasize quantity rather than quality, product rather than 
finish. We " lead the world " in the use of labor-saving 
machinery, but depend largely upon Europe for our skilled 
artisans. 

Growth of Population. — The mere growth of the American 
people has been as striking as it is familiar. In 1640 there were 
about 25,000 persons, excluding Indians, in British North 
America ; about 260,000 at the end of the seventeenth century 
according to Bancroft; according to the same authority the 
miUion mark was reached in 1743 ; and in 1790 the first federal 
census showed a population of 3,930,000 in the United States 
alone. In the next hundred years the population doubled every 
twenty-five years on an average, and although the rate of in- 
crease has fallen off somewhat since the Civil War, we are still 
growing at a remarkable pace, the population of continental 
United States being 91,970,000 in 1910. 

Despite this enormous increase, the population of this coun- 
try has not multiplied more rapidly than the means of subsistence. 
This does not mean that every one receives enough to live in 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 65 

comfort. On the contrary, great masses of people live in 
poverty. Neither does it mean that society as a whole produces 
enough to support every one in comfort, if the wealth produced 
were equitably or evenly divided. On the latter point there is 
deep difference of opinion. But with respect to the movement 
over long periods, say during the preceding century, there can 
be no doubt that wages and real income have risen, not without 
interruption, but with comparative steadiness. 

The dismal predictions of overpopulation which were so 
common in the first half of the nineteenth century have been 
signally discredited a.s practical propositions applicable to the 
American people of this epoch. The exploitation of national 
wealth, the improvement of business organization, and the inven- 
tion of labor-saving machinery have more than kept pace with 
the population ; and it appears that over long periods prosperity 
and high wages tend to depress rather than to raise the birth 
rate, even of the wage-earning population. We are in no danger 
of a " devastating torrent of children." 

On the contrary, the real problem of the twentieth century, or 
at least the problem that has evoked the greatest discussion, is 
found in the steady decline of the birth rate. According to some 
eminent authorities, the race is dying at the top, the ablest and 
most successful people have the smallest families ; and this 
constant sterilization of the ablest stock is, in the opinion of 
such authorities, second in importance to no problem which 
Western civilization is called upon to solve. It is not that we 
want more people. Population is still increasing with sufficient 
rapidity. The problem lies in the apparent failure of the most 
efl&cient individuals to multiply as rapidly as certain classes 
of the less efficient. Other authorities, it should be added, 
maintain that this " race suicide " has been going on for cen- 
turies, that it has not in the past, and will not in the future, 
lower the vitality or general efficiency of the race. Such writers 
view with complacency the ceaseless sterilization of the upper 
classes, maintaining that the process stimulates the ambition 
of the abler members of the lower classes by creating room at the 
top, and that so long as the habits and ideals of the upper classes 

F 



66 OUTLINES OF ECONOMICS 

remain wholesome, there is no cause for regret that the individ- 
uals who compose these classes are not self-perpetuating. 
Social heredity, not personal heredity, the preservation of sound 
morals, wholesome customs, and habits of social helpfulness, 
together with the opening up of new opportunities, are accord- 
ing to these writers the important factors. 

Second only in importance to " race suicide," and intimately 
connected with it, is the problem created by the rush to the city. 
In 1790 about 33 Americans in every thousand lived in a city of 
8000 inhabitants or more, in igio approximately 390 in every 
thousand lived in a city of this size. The mere facts in this 
connection are familiar to every one and need no elaboration. 
Their importance lies in the fact that the rush to the city is 
apparently universal, that it has been going on for centuries, 
and that it indefinitely complicates and aggravates the social, 
industrial, and political problems of our time. " Race suicide," 
for example, is more attributable to social conditions created 
by city life than to any physical incapacity of the women of 
this generation to bear children ; the evils commonly charged 
to the factory system are due as much to city crowding as to 
the factory system itself; and, speaking generally, whatever 
plan of reform for existing evils we devise or champion, we must 
reckon with this deep-rooted and persistent force which draws 
to the city so much of the best talent and ability which the rural 
districts produce. 

Slavery and the Negro Problem. — From the earliest period 
of settlement, one of our fundamental industrial problems has 
been to get enough labor to exploit the great national wealth of 
the country. The first solution attempted was by importing 
bondsmen or indentured servants. " Nearly all the immigrants 
that came (to Virginia) between 1620 and 1650 were bondsmen," 
and in 1680 an English official estimated that about 10,000 
persons were kidnaped or " spirited away " to America every 
year. This class of indentured servants consisted of runaway 
apprentices, penniless debtors, kidnaped children, honest 
laborers, vagrants, and criminals of all kinds. They were some- 
times subject to the most inhuman treatment, but, because 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 67 

they had white skins, soon melted into the free population and 
never created a race problem. 

The first negro slave landed in Virginia in 1619. For about 
thirty years they did not increase very rapidly, but after that, 
and until the close of the eighteenth century, they multiplied 
with greater rapidity than the white population. In 1790 there 
were 750,000 negroes or persons of negro descent in this country, 
constituting 19 per cent of the population. Since 1790 the 
negro population has steadily declined in relative importance, 
and in 19 10, numbering 9,830,000 in all, it constituted only 11 
per cent of the general population. The relative decline of the 
negro population is probably not due to white immigration, 
since the natural growth of the white population is markedly 
greater than that of the negroes in the South, where white 
immigration has been unimportant. The whites have increased 
faster than the negroes even in those countries in which the 
negroes greatly outnumber the whites.^ 

The negro problem to-day, so far as it is an economic problem, 
arises largely from the ignorance and economic weakness of 
the negroes and the exploitation to which their ignorance and 
weakness subject them ; from their concentration in certain 
narrow districts of the South, known as black belts; their 
dependence upon credit advances ; their inability readily to 
take up diversified farming and, outside of the farming dis- 
tricts, from the social pressure which confines them to a relatively 
few occupations, most of which — particularly as they practice 
them — are neither uplifting nor developmental. In 1900, for 
instance, 63 per cent of the male and 90 per cent of the female 
negro breadwinners were employed in unskilled trades. 

This condition of affairs is due in some degree to the economic 
inertia and shiftlessness of the negroes themselves. Con- 
sidering the circumstances attendant upon their introduc^tion 
into this country, it would be surprising if they were not 
economically backward. But present conditions are also due 

1 The greater increase of the whites "holds generally, though not universally, 
good in even the most overwhelmingly black of the black counties of the black belt." 
— John C. Rose, in American Economic Review, vol. iv, p. 292. 



68 OUTLINES OF ECONOMICS 

in part to race prejudice of their white brethren. There is a 
strong movement in the South today for enforced segregation 
of negroes, both in urban and rural communities ; and the trade 
unions evince a growing disinclination to receive negroes as 
members on the same status as white workmen. 

Vigorous efforts, however, are now being made in the South 
to provide industrial training of a systematic kind for the 
negroes ; and despite the asserted facts that " only 37 per cent 
of the negro school population of the South is in school attend- 
ance," that " in the rural South today not one black child in 
four is in school," and that " the public school system for 
negroes in the rural South is worse today than it was twenty 
years ago, with a smaller percentage of enrollment and smaller 
proportion of teachers," ^ the economic status of the negro in 
recent years, particularly that of the negro farmer, shows steady 
improvement. But yesterday a slave, it is inevitable that the 
negro should be forced to traverse in the forward path the 
intermediate steps of serfdom, peonage, and tenancy before 
becoming farm operative and owner. No class can be trans- 
formed in a day by legislative enactment from the status of 
slavery to that of free contract. In the South during the last 
census decade the number of negro farmers increased more 
rapidly than the number of white farmers ; the acreage of land 
operated by white farmers decreased while that operated by 
negro farmers increased 10 per cent ; the value of farm land 
and buildings owned by whites increased 117 per cent, but the 
value of farm land and buildings owned by negroes increased 
156 per cent ; while the number of negro farm owners increased 
17 per cent as contrasted with an increase of 12 per cent in 
the white owners of farms. The negro has been barred from 
the cotton mill. If the negro farmer can learn to raise some- 
thing other than cotton and raise it on something other than 
credit, he will probably have little cause to regret his exclusion 
from the cotton mill. 

Immigration. — Next in importance to the negro question is 

1 W. E. B. Du Bois, Quarterly Publications of the American Statistical Association, 
vol. xiii, p. 83. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 69 

the problem of immigration. We have always had an immigra- 
tion problem. " Governor Thomas Dongan, in 1685, made a 
report to the King of England full of dreadful forebodings as 
to the future of the ' Royal Province ' of New England unless 
the tendency to overcrowding were promptly checked. . . . 
George Washington and Thomas Jefferson are both recorded 
as opponents of an unrestricted policy of immigration, and it 
may be safely asserted that no considerable period has elapsed 
since their day without producing eloquent and forceful advo- 
cates of a rigid restrictive immigration policy." ^ Owing, how- 
ever, to the extraordinary increase of immigrants in recent years 
(the number rose from 3,840,000 in the decade ending in 1900 
to 8,796,000 in the decade ending in 1910) unusual interest in 
the subject has been aroused, the restrictive features of our law 
have been repeatedly strengthened, and on three occasions bills 
aiming to restrict the general volume of immigration by literacy 
tests have passed Congress only to be vetoed by the President. 
Most of the alarm which has recently been expressed, however, 
is due to the change in character, rather than the increase in 
volume, of our immigration. Instructive statistics bearing 
upon this point are given in Table I. Until nearly the last 
decade of the nineteenth century most of the immigrants came 
from the United Kingdom, Germany, and northwestern Europe, 
while since that time the arrivals have been largely from south- 
ern Europe ; and it appears that the new immigrants are more 
illiterate, much less likely to bring over their families and to 
remain permanently in this country, display less interest in 
taking out naturalization papers, and show a larger proportion 
of unskilled, as well as a smaller proportion of skilled laborers, 
than the earlier immigrants. " These people," it has been said, 
" have no history behind them which is of a nature to give en- 
couragement. They have none of the inherited instincts and 
tendencies which made it comparatively easy to deal with the 
immigration of the earlier time. They are beaten men from 
beaten races, representing the worst failures in the struggle 

1 Commissioner of Immigration, Robert Watchom, in The Outlook, vol. kxrsdi, 
p. 900. 



70 



OUTLINES OF ECONOMICS 



TABLE I 

Total Number of Immigrants (in Thousands) and Proportion coming 
FROM Designated Countries by Specified Periods: 1821-1910 ^ 





1821 


1851 


I86I 


1871 


1881 


I89I 


1901 




1850 


i860 


1870 


1880 


1890 


1900 


1910 


Total Number 


2456 


2598 


2315 


2812 


5247 


3844 


879s 


Per cent 
















Germany 


24.2 


36.6 


34-0 


25.6 


27.7 


I4.I 


3-9 


Great Britain 


15.0 


16.3 


26.2 


19-5 


15-4 


8.9 


6.0 


Ireland . . 


42.3 


35-2 


18.8 


I5-S 


12.S 


10.5 


3-8 


Norway, Sweden, and 




Denmark 


0.7 


0.9 


S-4 


8.6 


12.5 


9.9 


S-7 


Total 


82.2 


89.0 


84.4 


69.2 


68.1 


43-4 


19.4 


Austria Hungary 






0.4 


2.6 


6.7 


15-5 


24.4 


Italy 


0.2 


0-3 
0.1 


0-5 
0.2 


2.0 


5-Q 


17. 1 
iS-4 


23-3 
18.2 


Russia and Poland .... 


0.1 


1.8 


Total 


0-3 


0.4 


I.I 


6.4 


17.6 


48.0 


65-9 


All other Countries . . . 


17-5 


10.6 


14-5 


24.4 


14-3 


8.6 


14.7 


Grand Total 


lOO.O 


lOO.O 


1 00.0 


1 00.0 


lOO.O 


100. 


lOO.O 



for existence. Centuries are against them, as centuries were 
on the side of those who formerly came to us." ^ 

There can be no doubt about the real gravity of the problem. 
In times past charitable associations, and even certain foreign 
governments, " assisted " the poorest and neediest of their 

1 Data from Adams and Sumner, Labor Problems, p. 73, and the Slaiistical 
Abstract, igi3, p. 94. These figures are not exact and not altogether comparable, 
owing to changes in the immigration year, the distinction of nationalities, and the 
immigration laws. For the eSect of these changes, see Boeckh, " The Determina- 
tion of Racial Stock among American Immigrants," Publications of the American 
Statistical Association, December, igo6; and Willcox, National Civic Federation 
Review, November, December, 1906, p. 7. In the year ended June 30, 1914, the 
number of immigrants (1,220,000) was larger than in any previous year except 
1907, and Austria-Hungary, Italy, and Russia contributed 67 per cent of the total. 

2 Walker, "Restriction of Immigration," Discussions in Economics and Statistics, 
vol. ii, p. 447. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 7 1 

TABLE II 

Proportion of European Immigrants 14 Years of Age or Over Who 
CAN neither Read nor Write: i 899-1 909 ^ 

(Average proportion for all races, 26.6 per cent.) 



Under 15 Per Cent 


Over is Per Cent 


Race 


Per Cent 
Illiterate 


Race 


Per Cent 
Illiterate 


Bohemian and Moravian 
Dutch and Flemish . . 

English 

Finnish 

French 

German 

Irish 

Italian, North .... 

Magyar 

Scandinavian .... 

Scotch 

Spanish 

Welsh 

Not specified .... 


1-7 
4-7 

I.I 
1.4 

S-4 

S-i 

2.7 

11.8 

11.4 

0.4 

0.7 

14.6 

2.0 

6.7 


Armenian 

Bulgarian, Servian, and 

Montenegrin .... 
Croatian and Slovenian . 
Dalmatian, Bosnian, and 

Herzegovinian . . . 

Greek 

Hebrew 

Itahan, South .... 

Lithuanian 

Polish 

Portuguese 

Rumanian 

Russian 

Ruthenian 

Slovak 

Syrian . 

Turkish 


24.1 
41.8 

36.4 

36-4 
27.0 

25-7 
54.2 
48.8 

35-4 
68.2 

34-7 
38.5 
51.0 
22.1 
54-1 
58.9 



citizens to migrate to this country; famine and revolution in 
Europe spurred the impecunious and the radical to take refuge 
among us; regularly, also, the tide of immigration has ebbed 
and risen in close correspondence with the business prosperity 
of this country, artificially swelling our laboring population in 
times of industrial activity, encouraging our industrial managers 
in their spasmodic, jerky methods of production, and thus 
augmenting the severity of our alternating periods of industrial 
depression. Moreover, in certain industries the immigrant 
with his relatively low standard of living has driven out the 
native workman ; and most of the immigrants have shown an 
unfortunate tendency to linger in the cities of the eastern sea- 

1 Data from Jcnks and Lauck, The Immigration Problem, 3d ed., p. 35. 



72 OUTLINES OF ECONOMICS 

board, swarming in the slums and intensifying all those social 
evils which have their origin in urban congestion. 

The problem is chiefly economic, and the social or moral 
delinquencies of the newer immigrants have been greatly exag- 
gerated. Thus, the new immigrants are far less given to alco- 
holic excesses than the old. But the investigations of the United 
States Immigration Commission, to quote from its report, 
" show an oversupply of unskilled labor in the industries of the 
country as a whole," and the Commission recommends that 
" a sufficient number be debarred to produce a marked effect 
upon the present supply of unskilled labor." " As far as 
possible," the report continues, " the aliens excluded should be 
those who come to this country with no. intention to become 
American citizens or even to maintain a permanent residence 
here. ..." A majority of the Commission recommended the 
literacy test as the " most feasible single method " of properly 
restricting immigration ; realizing that it would cause occa- 
sional hardship — as any standard must — and that not 
all literate immigrants are desirable, and not all illiterate immi- 
grants undesirable ; but favoring it because it offers a practicable 
and simple means by which to reduce numbers without impairing 
quality or discriminating against particular nationalities. Not 
in individual cases, but in the net result, the literacy test would 
debar those classes which exploit America rather than strengthen 
it, and fail to rise to its real opportunities and responsibilities. 
Back of the demand for restriction is not the " American " 
snob, but the trade union. 

In the light of history, on the other hand, the immigration 
problem is far less alarming than it is in the dry light of recent 
statistics. In the first place, the statistics themselves, as ordi- 
narily published, are misleading, because they take no account 
of the large number of immigrants who return to Europe. The 
most recent census statistics (1910) indicate that about " two 
fifths oi the immigrants who arrived in the United States during 
the decade 1900-1910 either left the United States or died before 
the end of the decade." In the second place, the importance 
of the number of immigrants depends largely upon its relation 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 73 

to the population of the country ; and relatively to the popula- 
tion immigration seems to be declining rather than increasing. 
For instance, the proportion of foreign born in the population 
has varied very little since i860; and immigration reckoned 
in proportion to the population was heavier in the period 1850- 
1855 than in the period 1900-1905. In the next place, it is to 
be noted that our immigration laws regarding the exclusion of 
diseased, criminal, immoral, feeble-minded, and indigent persons 
are constantly becoming stricter and their administration more 
efficient. In addition to the plainly undesirable classes just 
noted, Chinese laborers have been excluded since 1882, aliens 
under contract to take up particular work since 1885, and an- 
archists since 1903. Finally, and most important, perhaps, 
agencies for educating, distributing, and Americanizing the 
immigrants have multiplied with great rapidity in recent years. 
Social settlements, vocational and night schools have under- 
taken the work of educating the immigrant ; many important 
labor unions have learned to organize the immigrants, and so 
make of them allies and not enemies in the task of maintaining 
and improving conditions of employment ; federal and state 
bureaus of information assist in the proper distribution of the 
immigrants, and public employment bureaus in finding work 
for them ; while a group of powerful and philanthropic immi- 
grant aid societies like the Italian Immigrant Bureau and the 
Hebrew Sheltering and Immigrant Aid Society "^ do effective 
work in Americanizing the immigrant, finding employment for 
him at good wages, overcoming tendencies toward congestion, 
effecting distribution, and promoting acquisition of American 
standards of living and thinking." ^ 

Surveying the whole history of immigration, three general 
conclusions may be drawn which must be fully considered by 
those engaged in the solution of the present problem. 

I. We have, as a people, shown a marvelous ability to assimi- 
late rapidly people of diverse races, tongues, and religions, amal- 
gamate them and stamp them with the characteristic qualities 
of the American. Even at the close of the eighteenth century, 

' Max J. Kohler, American Economic Review, vol. iv, p. 107. 



74 OUTLINES OF ECONOMICS 

about one fifth of the population spoke some other language 
than English as their mother tongue, and probably one half of 
the population were of other than Anglo-Saxon blood. The 
heterogeneous character of the population is illustrated by the 
fact that nine of the men most prominent in the early history of 
New York represented as many different nationalities. 

2. We have failed, however, to amalgamate the Negro and 
the Chinese ; the incidental feature of a dark skin creates espe- 
cially difficult problems ; and it is this fact which makes it 
undesirable that Japanese, Chinese, or Hindu laborers should 
settle here in large numbers, particularly in separate " colonies." 
Despite the high qualities of some of these peoples, it is con- 
ceivable that they might come to this country in sufficient 
numbers to create a problem similar in character and gravity to 
the negro problem ; and if investigation show that there is real 
probability of such a result, they should be excluded, even though 
the danger be attributable to race prejudice of the natives rather 
than the clannishness and exclusiveness of the immigrants. 

3. In the main, however, the traditional policy of this country 
has been " to improve rather than to check immigration," 
and the burden of proof is upon those persons who would restrict 
immigration by arbitrarily lii^iting the number of immigrants; 

Natural Resources. — Next to the character of the people 
with which this continent has been stocked, the most powerful 
factor in shaping the economic development of the United States 
has been its enormous natural wealth. With a territory (ex- 
cluding Alaska and our insular possessions) more than three 
fourths as large as all Europe, indented, particularly on the 
eastern coast, with a large number of good harbors, intersected 
by internal waterways that make communication cheap and 
easy, endowed with water power that in the opinion of one 
authority is probably " more valuable than those of all other 
lands put together," marked by every variety of climate and 
soil, covered in many places, at least originally, with magnificent 
forests, and liberally stocked with almost every variety of 
mineral wealth, it is not surprising that at the present time the 
United States " leads the world " in the production of iron and 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 75 

Steel, cotton, coal, coffee, gold, silver, dairy products, corn, wheat, 
lead, lumber, tobacco, petroleum, and hogs. It would be strange, 
indeed, with the vast mineral and agricultural resources at our 
command, if we did not " lead the world " in many things. 

Public Lands. — Of our 2,973,000. square miles of territory 
about three fourths at one time or another has belonged to 
the central government. The possession of this vast common 
treasure by the United States has played an important part in 
dignifying and strengthening the federal government. But the 
lavish alienation of the public lands in endowing free schools, 
subsidizing railways and other internal-improvement com- 
panies, and in providing free homes for the landless, has been 
an even more potent factor in hastening our economic develop- 
ment ; though it has led, as has been said with some justifi- 
cation, " to the ravishment rather than the development of our 
natural resources." 

Even more important is the influence which " free land " 
has exerted upon the wages of labor and the distribution of 
wealth in this country. While it was not until the passage of 
the Homestead Act in 1862 that land could be legally acquired 
without cost by simple occupation and cultivation, it is practi- 
cally true to say that from the seventeenth century until a few 
years ago any enterprising citizen could, by the exercise of a 
minimum amount of industry and frugality, secure a homestead 
large enough to support himself and family. This opportunity 
offered to the artisan a free choice between wage service and 
farming, constantly depleted the ranks of mere laborers, operated 
to keep wages as high as the earnings of a " no-rent " homestead, 
and kept fresh and vigorous that feeling of independence which 
has been the distinguishing mark of the American workingman. 
Up to June 30, 1909, according to President Van Hise, the United 
States had sold or disposed of to corporations and individuals 
571,600,000 acres; it had granted to the states for various 
purposes 153,500,000 acres ; 324,500,000 acres had been reserved 
for parks, forests, and other public purposes ; while there were 
363,300,000 acres still unreserved and unappropriated, not 
counting 378,000,000 acres in Alaska, of which all but about 



76 OUTLINES OF ECONOMICS 

10,000,000 acres were unappropriated and unreserved. The 
lands which were sold brought less than it cost to acquire, survey, 
and carry them. At the date mentioned 127,000,000 acres 
had been given away under the Homestead and Timber Culture 
Acts — supposedly to actual settlers — and 142,000,000 had 
been given to corporations to stimulate the building of railroads 
and other internal improvements.^ 

How long the public lands will hold out it is impossible to 
say. Notwithstanding the fact that the national government 
is disposing of its lands at the rate of from fifteen to twenty 
million acres a year, there is still left — if we count Alaska — 
almost as much territory as we have alienated since the adoption 
of the Constitution. Most of this is worthless or unavailable ; 
but irrigation and dry farming are reclaiming certain districts. 

In the East, especially, we have almost certainly entered upon 
a new era, and it must be remembered that fifteen sixteenths of 
the population reside in the eastern half of the United States. 
East of the Mississippi trade and manufactures taken together 
have outstripped agriculture, and a large majority of the people 
lack the inclination and necessary training, even if they possessed 
the courage and energy, to avail themselves of possibly cheaper 
lands elsewhere. Whatever the quaUty of this cheap land, its 
importance has diminished as an outlet for the population upon 
whose economic condition it formerly exerted so salutary an 
influence. Considering the population as a whole, the conclu- 
sion seems irresistible that we have reached, if indeed we have 
not already passed, the parting of the ways ; and the assistance 
that free land has rendered in maintaining wages and restrain- 
ing the evil tendencies of the modern system of capitalistic 
production must in the future be secured from other sources. 
The distinctive Americanism of the past was generated, as has 
been said, in the performance of our national task " of winning 
a continent from nature and subduing it to the uses of man " ; ^ 
it was a product of the frontier. But the frontier has now dis- 
appeared. 

1 Charles R. Van Hise, The Conservation of Natural Resources in the United States 
p. 294. ^ E. L. Bogart, Economic History of the United States, p. i. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 77 

QUESTIONS 

1. What peculiar characteristics mark the economic stages of the United 
States? 

2. Is the pastoral stage through which the people of our Great Plains 
have passed essentially different from the pastoral stage through which the 
people of Israel passed? 

3. Enumerate the great sectional struggles which have disturbed the 
United States. Why does radicalism accompany the frontier? 

4. Has the frontier and the work of settlement left a permanent impress 
upon the American people? Of what kind? 4|h 

5. How rapidly is the popidation increasing at the present time ? Are the 
richer or poorer classes multiplying more rapidly? Can you state the 
reason ? 

6. What are the distinctively economic factors of the negro problem? 

7. ■ When did the immigration problem first alarm residents of this 
country? Wliat charges are directed against the "newer immigrants"? 

8. Have we shown an abihty to assimilate all kinds of immigrants? 
What has been the historical policy of this country toward immigration? 

9. What part did the public domain play in bringing about and preserv- 
ing the Union? in maintaining wages? 

10. How does the growing size of the country modify the influence 
exerted by free land? 

REFERENCES 

BoGART, E. L. Economic History of the United States. Contains bibli- 
ography. 

Bruce, P. A. Economic History of Virginia (2 volumes). 

Bureau of the Census. A Century of Popidation Growth. 

Callender, G. S. Selections from the Economic History of the United 
States. 

CoMAN, Katharin'j;. Industrial History of the United States. Contains 
bibliography. 

Economic Beginnings of the Far West (2 volumes). 

Commons, J. R. Races and Immigrants in America. 

Emery, H. C. "Economic Development of the United States," in The 
Cambridge Modern History, Vol. vii, Chap, xxiii. 

Fairchild, H. p. Immigration. 

Hart, A. B. (ed.) The American Nation {t,'j vohime's). Contains chapters 
on economic history. 

HoURWiCH, I. A. Immigration and Labor. 

Jenks, J. W., and Lauck, W. J. The Immigration Problem. 

McM ASTER, J. B. A History of the People of the United States (8 volumes). 

Ross, E. A. The Old World in the New. 

Semple, E. C. American History and its Geographical Conditions. 



78 OUTLINES OF ECONOMICS 

SmoNS, A. M. Social Forces in American History. 

Turner, F. J. "The Significance of the Frontier in American History," in 
Bullock, C. J., Selected Readhigs in Economics. First edition in Re- 
port of the American Historical Association, 1893. 

United States Immigration Commission. Reports (39 volumes, including 
useful Abstracts of Reports, in 2 volumes). 

Van Hise, C. R. The Conservation of Natural Resources in the United Stdtes. 

Weeden, W. B. Economic and Social History of New England (2 volumes). 

Wellington, R. G. The Political and Sectional Influence of the Public 
Latids. 



CHAPTER VI 

THE ECONOMIC DEVELOPMENT OF THE UNITED 
STATES {Continued) 

In the preceding chapter attention was confined to certain 
fundamental and pecuharly American conditions which have 
influenced the economic development of this country. They 
form the background and setting of the picture. When we 
come to fill in the details, however, the general effect is very 
similar to that produced by the description of English industrial 
development given in Chapter IV. There are differences, of 
course, — differences important enough to make this separate 
discussion of American economic evolution necessary. But, 
on the whole, it is surprising how rapidly we have developed 
the industrial maladies and economic problems of the Old 
World. 

Mercantilism in America. — In the American colonies, as in 
England itself, the Industrial Revolution was preceded by a 
period in which trade and industry were subject to minute regu- 
lation by the government. Bounties were freely offered in 
several colonies for the manufacture of leather, iron, paper, 
silk, and cloth ; land grants were made and taxes remitted, 
particularly in the support of the iron industry ; and in order to 
encourage the home manufacture of shoes, for instance, -the 
General Court of Massachusetts in 1640 commanded that 
"every hide " be sent to a tannery under penalty of a £12 fine," 
while " leather searchers " were appointed to see that the law 
was obeyed. 

This early colonial regulation was restrictive as well as protec- 
tive. In the New England colonies, in the seventeenth century, 
laws were repeatedly passed prohibiting idleness, fixing the hours 

79 



K 



8o OUTLINES OF ECONOMICS 

of labor, and prescribing rates of wages, with appropriate penal- 
ties for v>^orkmen who took or employers who paid more than the 
legal rate. In the Boston Town Records of 1635, for instance, 
we find this resolution : " That Mr. William Hutchinson, Mr. 
William Colborne and Mr. William Breton shall sett pryces 
upon all cattel, comodities, victuals and labourers and Work- 
men's Wages and that noe other prises or rates shal be given 
or taken." But the restrictive laws, in general, failed dismally. 
The abundance of cheap land and the independent spirit gener- 
ated by the pioneer life prevented the enforcement of obnoxious 
colonial laws, and eventually led the colonists into armed resist- 
ance against the restrictive legislation of the English govern- 
ment. 

English Colonial Policy and the Navigation Acts. — In 
accordance with mercantilist views of colonial relationships, 
English statesmen of this period looked upon a colony as a 
community which was to supply raw materials for the industries 
of the mother country, secure its manufactured goods from the 
mother country; and so far as trade with the rest of the world 
was concerned, buy and sell through the mother country. In 
accordance with this general policy England gave bounties 
for the production in America of raw materials such as flax, 
indigo, naval stores, barrel staves, and the like, but restricted 
manufacturing proper — by prohibiting, for instance, the erec- 
tion of mills for slitting or rolling iron, and furnaces for making 
steel — and fettered our commerce in a variety of ways. 

The English laws were not so severe as might be inferred 
from our brief statement of their nature and purpose ; they were 
laxly enforced ; and it is to be remembered that England 
encouraged some industries while she attempted to destroy 
others. English colonial policy of this period was not so much 
malicious as mistaken. The important points for us are these : 
that it did not seriously hamper the development of American 
industry in general, while it did strengthen and stimulate in the 
American people that spirit of individualism which the industrial 
opportunities of the New World and the frontier conditions of the 
time combined to create. As a consequence the new nation, 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 8l 

created in 1789, was pledged to the doctrine of individual liberty, 
and its constitution contained specific guarantees of personal 
freedom not only in matters political, but in industrial and 
social relationships as well. 

American Industries in 1776. — When the Revolutionary 
War broke out, American industry was still in a primitive stage. 
The extractive industries were, relatively, the most advanced. 
Large quantities of lumber and timber products were exported 
to Europe ; the fisheries were in a prosperous condition ; and 
shipbuilding had reached a really remarkable stage of develop- 
ment, — in 1775 " nearly one third of the tonnage afloat under 
the British flag had been built in American dockyards." Agri- 
culture, however, was carried on in the most wasteful and un- 
scientific way, owing to the cheapness and fertility of the soil ; 
and manufacturing was still in the household stage. In the 
middle and New England Colonies spinning and weaving, the 
manufacture of shoes and food products, were carried on within 
the home; and, in fact, the typical farm household of this 
period constituted almost an independent economic unit, rais- 
ing or making what its occupants consumed, and buying little 
save salt and a few necessary iron implements. Of manufactur- 
ing for sale and export, however, there was little worth men- 
tion. The absence of adequate means of transport was largely 
responsible for this state of affairs. The roads were little 
more than widened Indian trails. Some years later, when con- 
ditions were considerably improved, the roads were still so poor 
that " Madison spent a week going from New York to Boston 
by stage, while the cost of cartage of a cord of wood for a dis- 
tance of twelve miles was three dollars." Agriculture, however, 
was the dominant industry of the country. In 1787 less than 
one eighth of the working population was engaged in manu- 
factures, fishing, navigation, and trade combined. 

The Industrial Revolution in America. — The Industrial 
Revolution was sudden, and in its consequences momentous 
in America as well as in England. The Revolutionary War, by 
interrupting trade with Europe, threw the American people 
upon their own resources : goods that had hitherto been im- 

G 



82 OUTLINES OF ECONOMICS 

ported had now to be manufactured at home ; a large number of 
new industries sprang up rapidly ; and the idea became prev- 
alent that the new nation must make itself industrially as 
well as politically independent of the Old World. The state 
governments endeavored to foster the new industries by protec- 
tive tariffs, and this policy was later continued, in a moderate 
form, by the federal tariff act of July 4, 1789. Prizes were 
offered by various societies, and even by certain state govern- 
ments, for the introduction of the new machines and methods 
which were revolutionizing industry in England. Attracted 
by one of these offers, Samuel Slater, " the father of American 
manufactures," who had been apprenticed to a manufacturer 
of cotton machinery, and was particurarly familiar with Ark- 
wright's machines and processes, came to this country in 1789, 
and in the following year started the first cotton factory at Paw- 
tucket, Rhode Island. 

The factory system secured its first real foothold, however, 
between 1806 and 181 5, when the Non-Intercourse Acts, the 
Embargo, and the War of 181 2, by suppressing trade with 
Europe, forced the American people to do their own manu- 
facturing, and turned large amounts of capital, which had pre- 
viously been employed in trade and shipping, into manu- 
factures. The growth during this period of isolation was 
extraordinary. In 1804 only four cotton mills were in opera- 
tion. " In 1807 there were fifteen cotton mills running 8000 
spindles and producing 300,000 pounds of cotton yarn annually. 
In 181 1 there were eighty-seven mills operating 80,000 spindles, 
producing 2,880,000 pounds of yarn per year and employing 
4000 men, women, and children. In 181 5, 500,000 spindles 
gave employment to 76,000 persons, with a pay-roll of $15,000,- 
000 per year." ^ When resumption of peace with Great Britain 
opened the new American industries to the fierce competition 
of the older English manufacturers, many failures and much 
suffering ensued, as a consequence of which increased protec- 
tion was granted in the tariff acts of 1816, 1824, and 1828. 
A little later, in the Middle Atlantic and New England states, 

1 Coman, Industrial History of the United States, p. i8i. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 83 

the period of factory production had fully arrived. A separate 
class of wage earners was appearing, who were especially ap- 
pealed to by new arguments concerning wages in the tariff 
discussions ; workingmen's parties were organized ; strikes and 
trades unions multiplied, and the latter were combined into 
municipal and state federations; in the thirties and forties 
radical reformers linked the " white slaves " of the North with 
the negro slaves of the South and worked for the abolition of 
both " wage and chattel slavery " ; the factory town and the 
city slum became recognized economic conditions, and the 
dangers of the latter were multiplied by the heavy immigration 
after 1845. By the middle of the nineteenth century the 
Industrial Revolution was in full sway, and the economic 
triumph of modern capitalism was assured. 

As might be supposed, the Industrial Revolution produced 
far less suffering and want in the United States than in England. 
The evils attributable to the Industrial Revolution in England 
were of two kinds. One arose from the rapidity and magnitude 
of the industrial change itself; the other was due, not to the 
change, but to the system under which the new industry was 
conducted — the system of capitalistic industry working in a 
regime of practically unregulated competition. In our country 
the evils resulting from transition alone were slight. Our 
manufacturing industries were scarcely started when the spin- 
ning jenny, the power loom, and the steam engine were intro- 
duced, and so almost from the beginning the factory system 
seemed the natural one. Thus, the change which in England 
was a revolution was in America an evolution, a process of 
construction with little destruction. And for a time even 
those evils inherent in the system itself were mitigated and 
disguised by the immense natural wealth of this country, the 
ease with which land could be obtained, and the unusual 
mobility of our working people which permitted them to take 
quick advantage of the unusual opportunities open to them. 

But these ameliorating agencies served only to check and 
delay, not to destroy, the evil possibilities of the new industrial 
system. As free land has become less and less abundant, the 



84 OUTLINES OF ECONOMICS 

wage earners of the East have had forced upon them conditions 
of Hfe which have kept down, although they have not absolutely- 
lowered, their standard of life. Extremes of wealth and aliena- 
tion of social classes have become so great as to arouse the appre- 
hension of all thoughtful men. Labor riots that call for mili- 
tary interference testify to the fact that we have not escaped, 
that in the future we can hope less and less to escape, the fric- 
tion that accompanies all unfraternal relations among men. We 
have been greatly blest in that we have escaped the worst results 
so long. 

The Development of Agriculture. — The presence and power 
of those economic forces which softened the asperities of the new 
industrial system in America are revealed in a particularly strik- 
ing way in the history of American agriculture. In England, it 
will be remembered, the changes in agriculture intensified the 
evils of the Industrial Revolution, led to the consolidation of 
small farms into large landed estates, and put the actual busi- 
ness of farming largely into the hands of tenants. None of 
these things happened in the United States. The great area 
of unoccupied land served as an outlet for our rapidly growing 
population, so that between 1850 and 1900 the number, acreage, 
and output of our farms increased more rapidly than our popu- 
lation. Farms were not consolidated but broken up ; even 
today nearly two thirds of our farms are operated by their 
owners, and more persons are employed in agriciilture than in 
any other branch of industry. There is a constant migration 
from the country to the city, to be sure, but this is in no sense 
due to the consolidation of farms. Thus between 1880 and 1910 
the proportion of all " breadwinners " (persons ten years of age 
and over gainfully occupied) engaged in agriculture fell from 
44.4 to 32.9 per cent. But great improvement in agricultural 
methods and machinery made it possible for the relatively 
smaller farm population to satisfy the demand for agricultural 
produce even more completely at the end than in the middle 
of the nineteenth century. That is to say, the machine power 
introduced into farming more than took the place of those 
persons and their descendants who abandoned agriculture. It 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 85 

has been estimated, for instance, that in 1895 it actually re- 
quired only about 120,000,000 days' work to produce the nine 
principal farm crops of that year, whereas, had they been pro- 
duced by the methods and machinery of 1850, at least 570,000,- 
000 days' work would have been required.^ 

But our free land merely served to postpone, it could not per- 
manently prevent, the appearance in America of some of the 
agricultural conditions which accompanied the Industrial 
Revolution in England. The twentieth century ushered in a 
new era in American agricultural development. Between 1900 
and 1 9 10 the number and acreage of farms increased far less 
rapidly than the population, while farm tenaricy grew, in 
close relationship, apparently, with an extraordinary increase 
in farm values. " The increase during the last ten years 
(1900-1910) in the value of farm property was equal to the 
total increase in the value of farm property in the United States 
from the landing of Columbus until 1900." ^ The value of 
farm land increased 118 per cent between 1900 and 19 10; 
and the number of farms operated by tenants increased 16.3 
per cent as against an increase of 8.1 per cent in the number of 
farms operated by owners. More important still, the average 
value of land, buildings and equipment per farm increased from 
$3560 in 1900 to $6440 in 1910. These figures reflect in part 
a simple change in the value of money ; but they indicate as 
well the increasing importance of capitalistic methods of pro- 
duction in agriculture, the increasing difficulty of acquiring 
farm ownership, and the sharp halt which has been called upon 
the agricultural expansion which marked the last century. 
" We have now reached a stage in the history of this country 
when farmers in average years do not produce much more of 
the raw materials used for food, beverage, and clothing than is 
needed within the country." ^ 

^ H. W. Quaintance, "The Influence of Farm Machinery on Production and 
Labor," Publications 0/ the American Economic Association, Third Series, vol. v, 
No. 4, pp. 27-20. 

* J. L. Coulter, "Agriculture in the United States," Quarterly Journal of Econom- 
ics, vol. xxvii, pp. 9-13. 

^ Coulter, loc. cit. 



86 OUTLINES OF ECONOMICS 

Manufactures. — ■ In agriculture, however, the passage of 
time has not brought about a highly capitalized form of indus- 
try, the typical farm represents only a relatively small invest- 
ment and is tilled by its owner, there is no sharp distinction 
between employees, unions of wage earners are practically un- 
known, and passage from the wage-earning to the employing 
class is still common. In manufactures, practically all these 
conditions have been reversed since the end of the eighteenth 
century. And it is the tone of the manufacturing industry 
rather than that of agriculture which represents the keynote 
of the modern economic movement, because agriculture is 
constantly decreasing while manufacturing and allied industries 
are constantly increasing in relative importance. At the be- 
ginning of the last decade of the eighteenth century, seven 
eighths of the working population were employed in agriculture, 
and the manufactured products of the country were valued at 
$20,000,000. Half a century later, in 1840, 77.5 per cent were 
employed in agriculture, 16.5 per cent in trades and manu- 
factures alone, and the products of the manufacturing industries 
were valued at $483,000,000. Fifty years later, in 1890, 35.7 
per cent were in. agriculture, 24.4 per cent in manufacturing 
and mechanical pursuits, and the manufactured products 
were valued at $9,370,000,000. In 1909, to cite the latest 
figures, 32.9 per cent were in agriculture and 28.3 per cent in 
manufacturing and mechanical pursuits, while the value of the 
products had reached the enormous sum of $20,700,000,000. 

The change in the character of the industry has been even 
more striking than its growth and expansion. In the first 
place, machinery and capital have become increasingly promi- 
nent. In 1850, for instance, $556 worth of capital was invested 
for each wage earner, while in '1909 the average amount of 
capital per wage earner was $2785.^ In the second place, the 
organization of the industry has changed, so that the individual 
owner and ordinary partnership are rapidly being replaced by 

1 Owing to variations in the definition of " capital " and other similar changes, 
the statistical comparisons made in this and the preceding paragraph are not accu- 
rate, and are to be accepted as illustrations rather than measurements. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 87 

the corporation. At the beginning of the nineteenth century, 
corporations, though not unknown in commerce and banking, 
were very uncommon in the manufacturing industries. In 
1909, incorporated companies employed 75.6 per cent of the 
wage earners and manufactured 79 per cent of the goods pro- 
duced in all the manufacturing industries. 

This change in organization has been a powerful factor in de- 
stroying the personal relation between the owners of capital 
and the wage earners who man their plants, and has thus 
helped to widen the growing breach between capital and labor. 
It has also contributed greatly to the concentration of industrial 
■control. Law and custom in this country have combined to 
make the small stockholder in the largest corporations a virtual 
nonentity so far as practical participation in the management 
of the corporation is concerned ; and the individual or clique 
of " insiders " who own a bare majority of the stock too fre- 
quently rule the business despotically. Incorporation,, then, 
instead of introducing a greater measure of real industrial co- 
operation and thus democratizing industry, has too often turned 
out to be an ingenious device by which energetic promoters 
borrow or secure the spare savings of the community on the 
most flexible terms and with a minimum of responsibility. The 
corporation thus, while it appeared to be diffusing the ownership 
of industry, has in reality worked toward the concentration of 
industrial control. 

Other forces, moreover, have been working toward industrial 
concentration, the most powerful of which, perhaps, has been 
competition itself. For many decades in this country the 
competition among rival manufacturers was bitter and 
practically unrestricted. Tied down to their large investments 
of fixed capital, they were compelled to stand and fight with- 
out quarter. In 'every such war the number of combatants 
tends to decrease. As old rivals are killed off, the successful 
acquire greater skill and greater power in the conflict. With 
the passage of time greater and greater equipment is required to 
give any hope of a successful struggle, and some of the contest- 
ants, learning prudence from the struggle, combine to increase 



88 OUTLINES OF ECONOMICS 

their fighting power. The inevitable result, whether through 
simple survival of the fittest or through combination, is a marked 
increase in the size and importance of the industrial unit. Be- 
tween 1899 and 1909, for instance, the number of establishments 
in the factory industries increased only 29.4 per cent, but their 
capital increased 105,3 Pcr cent, and the value of their products 
81.2 per cent. In many of our most important industries the 
number of establishments is actually decreasing. In the manu- 
facture of agricultural implements between 1880 and 1909, to 
take a single illustration of the many that might be cited, the 
number of establishments decreased from 1943 to 640, while 
the wage earneo-s increased from 39,580 to 50,551, and the value 
of the products from $68,640,000 to $146,330,000. 

There are industries, of course, in which no such consolida- 
tion has taken place, but they are unimportant in comparison 
with those in which it has. The extent to which the giant in- 
dustry and large-scale production had come to dominate our 
manufacturing industries in the year 1909 is shown in the follow- 
ing table, which will repay careful study. Establishments of 
the largest size, i.e. those whose annual output exceeded $1,000,- 
000, constituted a little over i per cent of the number of estab- 
lishments, but manufactured nearly 44 per cent of all the goods. 
Nearly three fourths of the wage earners were employed in 
establishments having a capital of more than $100,000 each. 

In the latter part of the nineteenth century the movement 
toward large-scale industry took on another phase. In addition 
to concentration or centralization of industry, we are now having 
a rapidly increasing integration of industry. Large business 
concerns are finding it profitable to carry on under one manage- 
ment several closely related industries. For illustration, take 
the case of the United States Steel Corporation. Here we have 
united under one management the American Bridge Company, 
the American Sheet Steel Company, the American Steel Hoop 
Company, the American Steel and Wire Company, the American 
Tin Plate Company, the Federal Steel Company, the Lake 
Superior Consolidated Iron Mines, the National Steel Company, 
the National Tube Company, and the Carnegie Steel Company. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 89 






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go OUTLINES OF ECONOMICS 

Of the last itself, Mr. Charles M. Schwab said in his testimony, 
before the Industrial Commission: ^ " The Carnegie Company- 
were large miners of ore — mined all the ore that they re- 
quired themselves, to the extent of over 4,000,000 tons per 
year. They transported a large percentage of it in their 
own boats over the lakes ; they carried a large percentage of 
it over their own railroad to their Pittsburgh works, and 
manufactured it there, by the various processes, into a great 
variety of iron and steel articles — I think perhaps a larger 
general variety of steel articles than almost any other manu- 
facturing concern." 

Transportation and Railways. — The industrial concentration 
of which we have been speaking does not necessarily lessen 
competition at all. It merely gives the business into the hands 
of increasingly powerful rivals among whom competition may 
be all the more bitter because of the size of the contestants. But 
in the principal transportation industries time has demonstrated 
that another rule prevails: competition has failed to protect 
the consumer, and the progress of consolidation has operated 
to emphasize the monopolistic character of the industry. 

The history of transportation in this country since the estab- 
lishment of the Union falls into three stages. The " turnpike 
period " extends from 1790, the year in which the first turnpike 
was constructed, until 181 6, when steam navigation upon the 
Ohio River became fairly regular. The second stage, the " river 
and canal period," ends after the panic of 1837, and is marked 
particularly by the introduction of steam travel on the Hudson 
(1807), the Ohio, and Mississippi rivers (1808 to 1817), and the 
opening of the Erie Canal in 1825. The last stage, the " period 
of the railway," extends from about 1842 to the present time. 
In contrasting these periods, it is not meant to suggest that 
canals were not built before 1790, or that turnpikes are not im- 
portant at the present time. As a matter of fact, a canal was 
built in Orange County, New York, as early as 1750; and the 
last few years have witnessed a rapid and costly improvement 
of our highways. These " periods " merely indicate the kind 

1 Report of the Industrial Commission, vol. xiii, p. 448. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 91 

of transportation facilities which at different times have been 
most prominent in the minds of the people. 

In the development of the railway, certain approximately 
definite stages may also be distinguished. Between 1830 (when 
the first important railway — the Baltimore and Ohio — was 
opened) and 1840, the railways were short local lines used in 
large degree to supplement or piece out the rivers and canals. 
In the next period, 1840 to 1870, many new roads were built, 
and the process of " linear consolidation " — the linking to- 
gether of local companies into through trunk lines — began. 
By 1869 both the New York Central and the Pennsylvania 
had effected through connections with Chicago. In the same 
year, the completion of the Central and Union Pacific railways 
linked the Pacific Ocean with the eastern railways, and the 
continent was spanned. 

The period between 1870 and 1890 is marked by three striking 
developments. First, it was a period of feverish expansion : 
the railway mileage of the country increased from 52,000 to 
160,000 miles, more than 200 per cent. Secondly, the com- 
pletion of several through routes from the Atlantic seaboard 
to Chicago brought about a period of destructive competition, 
which led to discrimination and rebating in through trafi&c and 
the overcharging of local or non-competitive trafl&c. " Wher- 
ever competition appeared, discrimination followed; and in 
the scramble for business the stronger shippers were favored 
at the expense of the weaker. Where there was no competition 
the public felt that they were being oppressed by a monopoly, to 
make up for sacrifice rates elsewhere — a feeling which was in- 
tensified by the absentee ownership of the western roads." ^ 
Thirdly, this condition of demoralization led to a double re- 
action. The railways sought to restrain competition by the 
creation of pools and traffic agreements, while the people sought 
to protect themselves through legislation and the creation of 
railway commissions. The Federal or Interstate Commerce 
Commission was established in 1887. 

The last period, from 1890 to the present time, has been 

1 H. C. Emery in The Cambridge Modern History, vol. vii, p. 706. 



92 OUTLINES OF ECONOMICS 

marked by an unprecedented amount of combination among 
competing roads, and by a growing belief that the railway indus- 
try is inherently monopolistic and must be subjected to public 
control. Thus, at the same time that the control of the magnifi- 
cent railway system of this country — greater in extent than 
all the railways of Europe combined — has fallen into the hands 
of a comparatively small number of groups, the people them- 
selves have perfected administrative machinery strong enough, 
it is hoped, to hold the monopoly in check. Very recently 
strong efforts have been made to preserve competition in the 
railway industry, but it is coming to be seen that in the main 
reliance will have to be placed upon regulation rather than 
competition. The amendment of the Interstate Commerce Act 
in 1906 is a public recognition of the fact that the old problem 
of private competition versus public regulation has given way 
to the new problem of public regulation versus public ownership ; 
and public operation may be given a trial in the near future 
on the thousand miles of railroad which Congress (in March, 
1 9 14) authorized the President to construct in Alaska. 

It would be almost impossible to exaggerate the part which transportation 
agencies, and particularly the railways, have played in the economic develop- 
ment of this country. Ours is a country of "magnificent distances," and 
because of this fact, it was particularly necessary that superior means of 
communication and transportation should be early introduced, if the country 
was to be held together. After the Revolutionary War there was real danger 
that the settlers west of the AUeghanies would be completely alienated. 
Washington v^as quick to realize this fact. "The Western settlers," he wrote 
to the governor of Virginia, shortly after the Revolutionary War, "stand as it 
were upon a pivot. The touch of a feather would turn them any way. They 
have looked down the Mississippi until the Spaniards, very impohticly, I 
think, for themselves, threw difiiculties in their way ; and they looked that 
way for no other reason than because they could glide gently down the 
stream, without considering, perhaps, the difficulties of the voyage back 
again, and the time necessary to perform it in ; and because they have no 
other means of coming to us but by long land transportations and imim- 
proved roads." 

This danger was averted by the building of the Cumberland Road, the 
introduction of steam navigation on the Ohio, and the completion of the Erie 
Canal. Later it looked as if the use of the Mississippi and other natural 
avenues of communication would link the Middle West more closely to the 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 93 

South than the northeastern states, thus giving the South a preponderant 
influence in the inevitable struggle over slavery. This problem, however, 
was solved by the railways, which, unlike the rivers, ran east and west rather 
than north and south. The railway was thus a strong factor in the preser- 
vation of the Union. And since the Civil War, western settlement has fol- 
lowed the railway. It has been the great pioneering agency of the last half 
century, and is entitled to as much credit as the pubKc land policy for the 
rapid settlement of the West. 

In the development of our transportation facilities, however, the State has 
been from the very first an active partner of private enterprise. Not only 
has the State built roads, canals, and railways of its own, but it subsidized 
the private companies which engaged in similar enterprises, with prodigal 
liberahty. Of the total state debts — $170,800,000 in aU — contracted 
prior to 1838, $60,200,000 were chargeable to canals, $42,870,000 to railways, 
$52,600,000 to banks, $6,600,000 to roads, and $8,500,000 to miscella- 
neous objects. After the panic of 1837 there was little direct construction 
by the State of internal improvements, but national, state, and local govern- 
ments vied with one another in assisting private companies by exemptions 
from taxation and by grants of land, money, and credit. How much these 
subsidies amounted to we do not know, but the aggregate must have been 
enormous, as appears from the statistics of land grants. "During the 
twenty-one years between 1850 and 1871, at which time land grants were 
discontinued, more than 159,000,000 acres were placed at the disposal of 
railroad corporations by the federal government and 55,000,000 by the 
state governments." ^ In their origin and genesis, therefore, as well as in 
their essential nature, the railways are quasi-publie institutions. 

The Labor Movement. — In the preceding pages we have 
seen how capitahstic industry under a regime of free competition 
passed from an earUer period of cut-throat rivalry to a later 
period of combination amounting in many cases to monopoly. 
A similar phenomenon is discernible in the labor movement. 
At the beginning of the nineteenth century there were probably 
less than a dozen trade unions in the United States, and we 
actually know of the existence of only one. Between 1825 and 
the panic of 1837, however, they multiplied rapidly, and efforts 
were made to unite the scattered " locals " of separate trades 
into broader national unions, and to confederate the unions of 
different trades into municipal and district federations. These 
efforts were only partially successful, however, and it was not 
* Bogart, Economic History of the United States, pp. igs, 30S, passim. 



94 OUTLINES OF ECONOMICS 

until after 1850 that permanent national unions were established, 
and not till the organization of the Knights of Labor in 1869 
that a fairly permanent national federation was created. The 
Knights of Labor reached the zenith of its power about 1886, 
and since the panic of 1893 its place has been gradually taken 
by the American Federation of Labor, with which most Ameri- 
can unions, except those of the bricklayers and masons, the 
Railway Brotherhoods, and the Industrial Workers of the 
World, are affiliated. In 1893 the membership of the American 
Federation of Labor numbered about 250,000. By 1914 it 
had grown to 2,020,671. These figures give some idea of 
the strikingly rapid growth of trade unionism in the last twenty 
years. As the membership of the American Federation of 
Labor is usually understated, and as there are probably about 
750,000 members in organizations not afiiliated with the Ameri- 
can Federation, we conclude that the aggregate membership 
of American labor organizations at the close of the year 19 14 
amounted to about 2,750,000 persons, mostly men.^ 

There are at least five periods distinguishable in the history 
of American trade unionism: the germinal period, 1 789-1825; 
the revolutionary period, 1825-1850, so called because of the 
close connection in this period between trade unionism and 
more radical reforms such as socialism and cooperation; the 
period of nationalization, 1 850-1 865; the period oi federation 
1865-1897 ; and the period of collective bargaining, 1898 to the 
present time. We speak of the present epoch as the period 
of collective bargaining because of the rapid expansion of union- 
ism, and the establishment of many new national or district 
systems of collective bargaining after the industrial depression 
of 1 893-1 897 ; and because it is only in recent years that em- 
ployers and the general public have recognized that the trade 
union is here to stay, and must be regarded as a permanent 
institution with which many employers of labor must bargain, 
whether they like it or not. 

1 Dr. Leo Wolman, in a recent careful study (Quarterly Journal of Economics, 
vol. XXX, p. 4q6), estimates the total trade union membership in the United States 
and Canada in igio as 2,223,000. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 95 

The avowed aim of the trade unions is a complete combination 
of all the workers in a given occupation or industry. The Broth- 
erhood of Locomotive Engineers, for instance, probably counts 
among its members more than go per cent of all the locomotive 
engineers in North America, although there are few trades 
which are so completely organized as this. With the passage of 
time, moreover, the trade unions have made increasing use of 
the monopolistic principle of the closed shop — the principle 
which leads union men to refuse to work with nonunion men, 
and which finds expression in the trade unionist's new command- 
ment: "Thou shalt not take thy neighbor's job." 

The development of powerful combinations in the labor world 
has engendered a counter movement among the employers, which 
expresses itself concretely in the modern employers^ association. 
Such organizations are not new; we have record of such an 
association among the master shoemakers of Philadelphia in 
1789. But in recent years these associations have become per- 
manent, formal, and aggressive. They fight the labor organiza- 
tions with their own weapons, matching the lockout against the 
strike, the black list against the boycott, and the " labor 
bureau " against the " unfair list " with which the reader of 
trade-union journals is familiar. Most of the employers' 
associations, like most of the trade unions, have associated 
themselves for common action in a large national federation, 
the Citizens' Industrial Association of America, with which, 
in December, 1903, there were affiliated sixty national em- 
ployers' associations, sixty-six State and district associations, 
and three hundred and thirty-five local or municipal associations 
of employers. 

This fight between organized labor and organized capital 
return has forced the State, in the interest of industrial peace, 
to inaugurate " Wage Boards " and Boards of Arbitration and 
Conciliation. Some of these, such as the New Zealand Court of 
Arbitration, are empowered to enforce their awards upon em- 
ployers and employees; while others, like the Canadian and 
some of the American State Boards of Arbitration, have no 
power to settle disputes authoritatively, although they may 



96 OUTLINES OF ECONOMICS 

make " compulsory investigations " and publish their finding 
as to the equities of the case. These and similar topics, how- 
ever, are reserved for more detailed discussion in a later chapter. 
State Regulation of Industry. — The growing interference of 
the State in the conflict between capital and labor brings us 
naturally to the general subject of the State in relation to indus- 
try. When the American colonies were planted, mercantilism 
was the dominant political philosophy; but, as we have seen, 
mercantilism gave way to a philosophy of individualism in the 
eighteenth century, under the combined influence of the reaction 
against the English Navigation Acts, the natural antipathy 
of a frontier community to legal restraint, the philosophy of 
Locke, and in a minor degree the teachings of the French physi- 
ocrats. The triumph of individualism, as a philosophical 
system, came at the critical period when our State and federal 
constitutions were in the making, and it thus became intrenched 
in the organic law of the nation, giving constitutional sanction 
to the doctrine of laissez-faire, and establishing a constitutional 
guarantee oi freedom of contract, in accordance with which adult 
men were leit " free " to work as long as they " pleased " (or were 
compelled), for whatever wages they were " pleased " (or forced) 
to accept. Under the influence of these doctrines, for instance, 
our courts have annulled such wholesome regulations as laws 
prohibiting payment of wages in store orders, and statutes 
limiting the hours of labor of men in bakeshops, or other ex- 
hausting occupations. Decades of experience have amply 
proved that the average wage earner is too weak to protect 
himself against many evils; but our constitutional law has 
made it exceedingly difficult for the State to protect him. For- 
tunately, however, the American people have a fashion of 
bending their constitutional law to fit the facts, not blinding 
themselves to the facts by worshiping the law ; and in recent 
years the Supreme Court of the United States has sanctioned 
laws requiring the semi-monthly payment of wages, prohibiting 
the payment of wages in goods, and requiring the wages of certain 
miners to be based upon the weight of the coal before screening. 
Many of the State courts, however, are far less enlightened. 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 97 

It is impossible to show in detail how the free trade and indi- 
vidualistic tendencies of the Revolutionary period gave way to 
a constantly growing program of State interference. The 
doctrine of laissez-faire was never adopted in its entirety, and 
year by year we have moved farther and farther away from it. 
State interference began with the adoption of a tariff act in 
1789, " for the support of the government, for the discharge of 
the debts of the United States, and the encouragement and 
protection of manufactures " ; reached almost a maximum in 
the Embargo Act of 1807 ; showed itself in the policy of internal 
improvements and State aid to turnpike, canal, and railway - 
companies; brought us the great mass of labor and factory 
legislation which has been adopted by so many states since the 
Civil War ; led in turn to the Interstate Commerce Act of 1887, 
the Sherman Anti- trust Act of 1890, the National Meat In- 
spection and Pure Food Laws; and finally culminated in the 
Clayton Anti-trust and the Federal Trade Commission Acts of 
1914. Excessive competition among laborers, which forced 
them to accept work under conditions destructive of physique 
and morals, has led to the factory acts, prohibition of child 
labor, and limitation of the hours of labor of women ; excessive 
competition leading to the adulteration of products and their 
manufacture under insanitary conditions has given us the meat 
inspection and pure food laws ; excessive competition among 
corporations, leading to combination and oppressive monopoly, 
has brought us the anti-trust acts and regulation through State 
and national commissions. The rapid adoption of workmen's / 
compensation and minimum wage laws by the State govern- 
ments in recent years, is striking evidence that we have entered 
a new era, in which State interference and control is not unlikely i 
to become excessive. Whether the individualistic character 
of industrial society endures or disappears, individualists and . 
sociaUsts alike are now agreed that the State must interfere.^ 
As a prominent English statesman expressed it, " We are all 
socialists now," although he merely meant by this statement 
that the passive theory of government has been wholly dis- 
credited. 



98 OUTLINES OF ECONOMICS 

Up to the present time State interference has had as its princi- 
pal object the improvement and preservation of competition. 
The conscientious manufacturer who would not poison con- 
sumers for the sake of swelling his profits, the high-minded 
employer who would not " sweat " women and children merely 
to reduce the cost of production, the delicately scrupulous 
shipper who would not undermine a rival by forcing a common 
carrier to pay him rebates, — all these have suffered as much 
from the abuses of competition as the general public itself. 
Industry under the competitive regime is a rough game played 
for high stakes, and if it is to be played fairly, there must be 
intelligent rules of the game and an umpire powerful enough 
to enforce them upon all contestants alike. If the manufacturers 
of Massachusetts are prohibited from employing children under 
fourteen years of age while those of South Carolina are en- 
couraged to do so, decency is penalized, and the victory goes to 
the contestant guilty of the greatest number of fouls. 

State interference, as we have said, has had as its principal 
object the maintenance of competition upon a higher and more 
wholesome basis. But this has not been its sole object. Our re- 
cent regulation of public utility companies aims not to bolster up 
or preserve competition among such companies, but to introduce 
a substitute for competition ; and it is possible that in certain 
lines of industry regulated monopoly may prove on the whole 
more beneficial than regulated competition. Whether it is 
desirable, whether in the long run it will be possible, to main- 
tain a competitive as distinguished from a socialistic regime 
of industrial society, may be said to be the supreme economic 
problem of the twentieth century. 

QUESTIONS 

1. How do you account for the failure of the early colonial restrictive 
legislation ? 

2. What was the effect of English colonial policy and the Navigation 
Acts upon American manufactures? shipbuilding? American poHtical 
philosophy ? 

3. What was the condition of American agriculture in 1776? of manu- 
factures? shipbuilding? transportation? 



ECONOMIC DEVELOPMENT OF THE UNITED STATES 99 

4. Was the Industrial Revolution as important in this country as in 
England? Was it attended with as much suffering? Why? 

5. What part has been played by war in the tariff and industrial history 
of the United States? 

6. In what respects has the agricultural development of this country 
differed from that of England? from that of the manufacturing industry? 

7. What changes have taken place in the organization of manufacturing 
industries in the last century? 

8. What are the principal causes and effects of industrial concentration? 

9. What is the difference between industrial concentration and integra- 
tion? between large-scale production and monopoly? 

10. What stages are distinguishable in the history of transportation and 
railways in this country? 

11. What part did the State play in the development of railways? Is 
railway consolidation a recent phenomenon? 

12. What movement has the development of trade unionism elicited 
from employers? from the State? 

13. How did the doctrine of non-interference secure such a strong foot- 
hold in American constitutional law? What has been the principal object 
of State interference up to the present time? 

REFERENCES 

(See also References for Chapter V) 

Beard, C. A. Contemporary American History. 

Beer, G. L. The Old Colonial System, 1660-1754. 

Bishop, J. L. History of American Manufactures. 

Bryn, E. W. Progress of Invention in the Nineteenth Century. 

Census Reports. Tenth Census, Agriculture, p. 131; Twelfth Census, 
Manufactures, Part i, Chap, ii, i-iv, xvii, xxxix. 

Cleveland, F. A., and Powell, F. W. Railroad Promotion and Capitaliza- 
tion in the United States. 

Commons, J. R. (ed.) Documentary History of American Industrial Society. 
(10 volumes.) 

Dewtey, D. R. Financial History of the United States. 

GiESECKE, A. A. American Commercial Legislation before ijSg. 

Hadley, a. T. Railroad Transportation, its History and its Laws. 

Johnson, E. R. American Railway Transportation. 

Rabbeno, Ujo. The American Commercial Policy. 

Taussig, F. W. Tariff History of the United States. 

Weber, A. F. "The Growth of Cities in the Nineteenth Century," Co- 
lumbia University Studies in History, Economics, and Public Law, 

■ Vol. ii. 

Wells, D. A. Recent Economic Changes. 

WiCKWARE, F. G. (ed.). The American Year Book. 



BOOK II 
PRINCIPLES AND PROBLEMS 



PART I 

PRODUCTION AND CONSUMPTION 

CHAPTER VII 
ELEMENTARY CONCEPTS 

In political economy many of the technical terms employed 
are often misunderstood because the same words are used in 
ordinary speech with inconsistency and confusion. Frequently 
we have to choose between the alternatives of being inconsistent 
and of violating current usage. The present chapter is devoted 
to a preliminary survey of some of the fundamental notions in 
political economy. 

The statement is sometimes made that economics is a mere 
bread-and-butter science, and this charge is not without some 
foundation, since the science studies men in their endeavor to 
make a living, but it would be an error to suppose that we are 
concerned with only the sordid aspects of human nature. This 
'is apparent if we enumerate the motives which impel men to 
acquire wealth. 

Motives in Economic Activity. — (i) There is, in the first 
place, the endeavor to satisfy one's strictly personal wants, 
giving rise to the struggle for food, shelter, comforts, amuse- 
ment, etc. These things are wanted for their own sake, because 
of the effect which they produce upon the individual acquiring 
them. We have here, in short, the motive of self -maintenance 
and self-development. (2) But every normal individual feels 
such a degree of affection for certain other people that he is 
also anxious for their maintenance and development. Striving 
for the welfare of others is a second motive which impels men to 
labor for the acquisition of material things, and in many cases 
is more effective as a spur to endeavor than the first. A man 

103 



I04 OUTLINES OF ECONOMICS 

will hold himself to the daily grind more persistently when he 
feels some one is dependent upon him than when he is standing 
alone. 

Another motive is (3) the desire to gain the esteem of one's 
fellows. This motive may take the form of an endeavor to do 
one's part and to be deserving of the companionship of the 
class of people whom we admire. But much of our wealth 
acquisition is motivated by the hope of impressing our fellows 
with a sense of our own importance, to show that we are success- 
ful, admirable, enviable. When the income permits, old coats 
are discarded, not because they cease to give protection, nor 
because they have become aesthetically objectionable, but 
because the wearers wish to make a favorable impression upon 
other people. Part of the pleasure of owning fine houses may 
come from the fact that most people do not have them. This 
motive is not always a conscious one, since our standards of 
beauty or propriety may themselves have been the result in 
part of this desire for distinction. Somewhat similar to the 
desire for distinction is (4) the desire for power. Men like to 
dominate and command their fellows, and this want may be 
satisfied by means of the dollar as well as with the sword; 
hence our " Napoleons of Finance," " Captains of Industry," 
and " Railway Kings." 

Again, (5) the desire for activity for its own sake may be men- 
tioned. Enforced idleness is as painful as prolonged labor, ex- 
cept to the degenerate. This desire may result in the production 
of goods, but almost always it requires the use of goods 
that have been produced ; as, for example, the implements of 
athletic exercise. Finally, (6) religion and the ethical sense 
may be important factors in controlling the economic 
activity of the individual. Observe, for instance, the dift"erence 
in the history of the communistic experiments in which religious 
feeling has been strong and those in which it has been weak. 

In this discussion the use of the word " motive " must not be 
taken to mean that all of the economic life of the individual 
is a consciously rational one, in which pleasures are balanced 
against pains in such a way as to secure the maximum surplus 



ELEMENTARY CONCEPTS 105 

of satisfactions. Man is, it is true, a rational being, and as 
such pursues definite lines of action under the influence of con- 
scious motives ; but he is also a creature of instincts and habits, 
and much of the economic activity of the individual has to be 
interpreted as the working out of instinct and habit. We speak, 
for example, of such things as the " instinct of workmanship," 
the " habit of industry," the " habit of saving," and the like. 
The foregoing analysis of the motives in economic activity is, 
however, broad enough if we remember that " pleasure " is 
something that is not always consciously sought, but is often 
to be understood as the result of the functioning of inherited 
instincts and acquired habits. 

Utility. — As a result of these motives, human beings are 
striving for the possession of certain things. These we call 
goods. To understand the meaning of the term " utility " in 
economics, we must remember that economics is primarily a 
science of man. Goods may be of interest in chemistry and 
physics merely as things, but they have no significance what- 
ever in economics until they come into relation with man. That 
fact in man which imparts to things a new character and makes 
them goods is the fact of human wants. Anything that is capa- 
ble 0} satisfying a human want is a good, and possesses utility. 

We need here to guard against a misunderstanding which the 
word " utility " might suggest. Utility is the power to satisfy 
wants, not the power to confer benefits. Cigars are as " useful " 
in the economic sense as bread or books, for all three satisfy 
wants. Economic wants may be serious, frivolous, or even 
positively pernicious, but the objects of these wants all alike 
possess utility in the economic sense. 

Free Goods and Economic Goods. — But it is apparent that 
the wants we have mentioned are very unlike in character. Air 
and water, for instance, we seldom think of as things we want 
at all. We usually have them in abundance and without exer- 
tion, so that, though they satisfy wants as vital as any we 
know, we seldom spend any time thinking about them or our 
absolute dependence upon them. These are free goods, that is, 
goods that exist in quantities sufficient to supply all wants for 



lo6 OUTLINES OF ECONOMICS 

them. Land in a new country is frequently a free good. But 
the list of things that are free is quickly exhausted. Economic 
goods are those which exist in quantities less than sufficient to 
satisfy all wants for them. Hence, we must economize in the 
use of them, are willing to undergo sacrifice to obtain them, 
and usually they are obtained only by exertion. It is, however, 
their scarcity as compared to the human wants which they have 
the power to satisfy, and not the fact that they have cost labor, 
that makes them economic goods. Land, for example, a free 
gift of nature, is one of the most important of economic goods 
at the present time. 

Effort. — Fortunately, the supply of economic goods can, in 
most cases, be increased by human exertion applied to the ma- 
terials of nature ; but this exertion, if carried beyond a certain 
point, is irksome, and this has an important effect upon the con- 
duct of life. If the labor force of the community were unlimited, 
a great many of the goods which we now use sparingly would be 
as free as air. Idealists have pictured for us a condition of the 
future where a few hours' work per day for each individual (an 
enjoyable means of working off surplus energy) will be sufficient 
to supply us with all of the goods that we have time to consume. 
At present, however, most of us find that our consumption is 
limited by the pain of additional effort. The end of our eco- 
nomic activity is, therefore, not only to get the greatest amount 
of satisfaction, but also to minimize the amount of painful labor. 

"Waiting. — Another fact that persists in our economic life 
is the necessity for waiting. The people of the United States 
wished to have the Panama Canal, but they could not get it 
without years of waiting. They were obliged to spend millions 
of days of labor with no benefit in return for a long time. So 
in general the production of goods by modern methods, involving 
the investment of capital, requires waiting as well as effort. 

Risk. — In a society characterized by private enterprise in 
industry, the risk of business failure is an important fact. 
The uncertainties of business life are obvious : A factory may be 
destroyed by fire, crops may be destroyed by storm and hail, 
a panic may destroy credit at a critical moment, fashions may 



ELEMENTARY CONCEPTS 1 07 

change, or competition may prove too strong. Some of these 
uncertainties may be eUminated by insurance, but others can- 
not be so eliminated. The corporation is a device by which 
the risk assumed by one individual is limited, although not 
eliminated. The trust and the monopoly tend to reduce the 
importance of the factor of risk, and under a system of State 
socialism it might possibly become a negligible factor in our 
daily economic life. As society is constituted at present, how- 
ever, the production of goods to satisfy human wants is attended 
by risk, and, as we shall see later, society has to compensate 
those who take these inevitable business risks. 

Services. — Goods have been commonly divided into (i) 
material things, such as food, clothes, and books, and (2) personal 
services, such as those of physicians, lawyers, musicians, teach- 
ers, household servants, and public oflScers. 

The advisability of the distinction has been denied. Actors and singers, 
it has been urged, sell us perishable material things, i.e. light and sound 
waves of a peculiar kind. A recent writer also considers the distinction con- 
fusing because it obscures the fact that material things render services just 
as human beings do. The piano yields services as does the singer. From 
this point of view persons are durable economic goods along with cattle and 
wheelbarrows. But, on whatever ground the distinction is made, it is im- 
portant to recognize that among the things that contribute to our well-being 
are some — personal services — that are so perishable that they must be 
used with the direct cooperation of some other human being, while in other 
cases the services are, as it were, stored up in some inanimate material things, 
and the relation between the producer and consumer becomes an impersonal 
one. The service of a musician, for example, is personal and must be used 
the moment it is rendered; the purchase of a musical instrument, on the 
other hand, means the purchase at one time of a long series of uses. 

Personal Qualities as Goods. — The central point in our 
science is the conception of man in his relations to his environ- 
ment, and hence it does not seem reasonable to include the 
personal qualities of men under the head of goods. Good health 
and technical skill make a man's services more valuable and 
assist him in the acquisition of wealth, but they are a part 
of him rather than of his possessions. It is his services that he 
sells, and it is these that we have placed under the head of goods. 



■ lo8 OUTLINES OF ECONOMICS 

When we consider the importance of the priceless heritage 
which the present generation has received in the shape of knowl- 
edge and skill, we might make these a separate category as 
immaterial goods. 

On this point Professor Marshall says: "German economists often lay 
stress on the non-material elements of national wealth ; and it is right to do 
this in some problems relating to national wealth, but not in all. Scientific 
knowledge, indeed, wherever discovered, soon becomes the property of the 
whole civilized world, and may be considered as cosmopolitan rather than a 
specially national wealth. The same is true of mechanical inventions and 
of many other improvements in the arts of production; and it is true of 
music. But those kinds of literature which lose their force by translation 
may be regarded as in a special sense the wealth of those nations in whose 
language they are written. And the organization of a free and weU-ordered 
State is to be regarded for some purposes as an important element of national 
wealth." 1 

But knowledge does not exist in a disembodied state, and we 
shall omit nothing and avoid some confusion if we divide all 
/ goods into material things and personal services. 

Wealth and Income. — Wealth may be looked upon either 
as a stock of things on hand at a particular time or as a flow of 
things during a period of time. When we ask how much a man 
is worth, it is customary in America to answer in terms of the 
value of his possessions, while an Englishman, would answer in 
terms of annual income. The two ways of looking at the 
matter are not identical, however: What a man spends in a 
year may include a good deal spent in hiring other persons to do 
personal service for him, while an estimate of his possessions 
• could not include the value of those persons unless they were 
his slaves. 

What is to be considered as a man's income is not easy to say, 
as our law-makers have discovered in framing income tax laws. 
In economic discussions we have in mind net and not gross 
income. We may refer to the economic goods and services 
enjoyed during a period of time, to the satisfaction derived 
from these goods and services, or to their money value. Money 
income is commonly given a broader meaning to cover one's 
^ Principles of Economics, 6th ed., p. 59. 



ELEMENTARY CONCEPTS 109 

total net acquisition of money regardless of whether it is spent 
for consumption goods or is saved. 

Individual Wealth and Social Wealth. — The distinction 
between the social and the individual standpoint meets us at 
many points in the study of economics. That which is wealth 
to the individual is often not wealth to society. An individual 
holding a government bond finds that he can exchange it for 
the things he wants almost as readily as though it were gold or 
some other commodity. He recognizes that the paper itself 
cannot be used directly for any useful purpose, yet he prizes 
it because it represents an indisputable claim on the services 
or commodities of other people. If the bond should be destroyed, 
the holder as an individual would suffer loss, but society as a 
whole would be neither richer nor poorer, and society, exclusive 
of the bondholder, would have gained at his expense. From 
the social standpoint the bond is not wealth at all, but only an 
evidence of a legal right to a part of the social wealth. All 
property rights are simply claims to a part of the social wealth 
or income. The claims to concrete, material things, such as 
farms and store buildings, are included by an individual when 
he enumerates his wealth; and farms and store buildings are 
social wealth. Again, in making an inventory of his wealth, 
an individual would not ordinarily include such an item as the 
post ofi&ce, which is public and not private property; but, 
strictly speaking, the post office is owned by him jointly with 
other members of society. A successful patent is frequently 
looked upon as an item of wealth, but it is simply a means by 
which the owner gets more from other people in return for his 
services. If the patent is declared invalid, others gain what he 
loses (not counting the lessening of the inducements to inven- 
tion). Again, " good will " in business is frequently paid for 
as though it was an economic good, and is wealth from the 
individual point of view, but it is not social wealth. If a busi- 
ness man loses his established trade, his competitors are the 
gainers ; society as a whole is not affected. 

Wealth and Value. — In the preceding paragraphs wealth has 
been spoken of as consisting of particular things. A lead pencil 



no OUTLINES OF ECONOMICS 

and the year's crop of wheat are both wealth. How shall we 
measure the amount of wealth that these objects represent ? 
Since the items of wealth are composed of very heterogeneous 
objects, we cannot use such units of measure as bushels, pounds, 
or feet. We must select a measure that has reference to some 
quality common to all kinds of wealth. Such a quality is 
value. This is a subject which will be discussed in detail later, 
the valuation of goods and personal services being the central 
problem in economic theory. 

Capital and Other Forms of Wealth. — Some material things, 
as well as personal services, yield satisfaction to human beings 
directly. From clothes, dwellings, food upon the table, musi- 
cal instruments, and the like, we derive enjoyment directly. 
These are consumption goods. Other goods are of service only 
indirectly. A plow, we say, is useful, but we cannot eat or wear 
it. It simply helps to produce the things that we can enjoy. 
Such articles are production goods. 

The distinction is a matter of degree. Even the food upon the table is not 
quite ready to be enjoyed. It must be handled with knives and forks. 
This has led some writers to make no distinction between production and 
consumption goods. But it has been pointed out that great differences in 
degree are more important than many differences in kind. The distinction, 
it may also be noted, is not made on the ground of durability. Consump- 
tion goods — a painting or a book, for example — may be very durable. 

Production goods, again, are divided into capital goods and 
land. Land is a gift of nature ; capital goods — machinery, 
warehouses, raw material, etc. — are produced by man. Other 
differences between these two classes will be discussed later. 

Capital Goods and Capital Value. — Capital goods, as well as 
other forms of wealth, are of such a heterogeneous nature that 
we cannot measure them by such units as pounds or inches. 
Here, again, we must select some quality that is common to all 
of them, which is value, and this can be measured in terms of 
dollars. Very frequently the value of capital goods is confused 
with the concrete good itself. A typewriter is a tangible, ma- 
terial capital good ; its weight is measured by pounds ; its bulk 
by cubic inches ; its value by dollars. In this book the word 



ELEMENTARY CONCEPTS 



III 



" capital " is frequently used as a short expression for either 
of the phrases " capital goods " and " capital value," but it 
will always be clear from the context which is meant. 

Social and Individual Capital. — The individual may include 
items in an enumeration of his capital which are not capital 
from the standpoint of society. The landlord who has dwell- 
ings to let regards them as part of his capital, but from the social 
standpoint they are consumption goods. We may call such 
goods acquisitive capital. Again, a street railway may consider 
its franchise as a part of its capital, but from the social stand- 
point a franchise is not capital at all, nor even wealth, but is 
simply a right to use the streets in a certain manner. Destroy 
the franchise, and social capital would not be lessened, except, 
perhaps, in indirect ways. 

Figure i will help to make these various distinctions clear : 

Circle AB represents goods. 
Circle AC represents economic 



Circle AE represents producer's 

s. 
Circle AF represents land. 
Zone BC represents free goods. 
Zone CE represents consumer's 

s. 
Zone DE represents acquisitive 



Zone EF represents social capi- 



tal. 




Fig. I. 



The National Wealth and the National Dividend. — Attempts 
have been made to ascertain the total wealth of a nation. The 
latest estimate made for the United States by the census authori- 
ties is given on the following page. 

Such a table is useful, even though it may contain some rather 
arbitrary estimates, as showing the relative importance of dif- 
ferent classes of our material equipment. Notice the small total 
value of the metals used as money and the relatively large value 
imputed to real property. It is rather surprising that manu- 



112 



OUTLINES OF ECONOMICS 



facturing machinery, tools, and implements are worth less than 
our live stock. But great care should be taken in comparing 
the total wealth as estimated in this and in preceding census 
valuations and in drawing conclusions as to the significance of a 
growth in national wealth measured in dollars. 

Estimates of Wealth for 191 2 and 1900 



Form of Wealth 


1912 


1900 


Total 


$187,739,071,090 


$88,517,306,775 




Real property and improvements taxed 
Real property and improvements exempt 
Live stock 


98,362,813,569 

12,313,519,502 

6,238,388,985 

1,368,224,548 

6,091,451,274 

2,616,642,734 

16,148,532,502 

4^596,563,292 

223,252,516 

1,081,433,227 

123,362,701 

1,491,117,193 
360,865,270 
290,000,000 

2,098,613,122 

5,240,019,651 

14,693,861,489 

826,632,467 

815,552,233 

4,295,008,593 

8,463,216,222 


46,324,839,234 

6,212,788,930 

3,306,473,278 

749,775,970 

2,541,046,639 
1,677,379,825 
9,035,732,000 

1,576,197,160 
211,650,000 
400,324,000 

98,836,600 
537,849,478 

267,752,468 

402,618,653 

1,455,069,323 

6,087,151,108 

424,970,592 

326,851,517 

2,000,000,000 

4,880,000,000 


Farm implements and machinery . . 
Manufacturing machinery, tools, and 

implements 

Gold and silver coin and bullion . 
Railroads and their equipment . . . 
Street railways, etc. : 

Street railways 

Telegraph systems 

Telephone systems 

Pullman and other cars not owned by 
railroads 

Shipping and canals 

Irrigation enterprises 

Privately owned waterworks . . . 

Privately owned central electric light 

and power stations 

All other : 

Agricultural products 

Manufactured products 

Imported merchandise 

Mining products 

Clothing and personal adornments 

Furniture, carriages, and kindred 
property 





In addition to the difficulty of getting accurate information 
on these various items, there are several things to be kept in 
mind in making use of such an estimate. First, the returns are 
made in money, so that fluctuations in the value of money will 
show a change in the total valuation even if there is no real 
change in the relation between the wants of a community and its 



ELEMENTARY CONCEPTS 1 13 

supply of goods. Again, free goods are not included in such 
an estimate. Also, a good deal of public property does not have 
a money estimate put upon it. Who would attempt to say what 
our rivers and harbors are worth, and yet why should not these 
be included in the estimate if our canals are ? 

It seems that much that is included in the estimate is wealth 
from the individual standpoint only, but not from the social, as 
in the case of the valuation of a business whose value consists 
largely of patents or monopolistic privileges. In the table above, 
for example, the value of railway property was obtained by capi- 
talizing railway earnings. Is this sum properly included in an 
estimate of the total amount of wealth in the United States? 
The inclusion is proper if we are confining ourselves to a state- 
ment of the sum of the values of property rights, but it is mis- 
leading if we wish to show the relative importance of railways 
and of property in a competitive industry, or if we are discussing 
railways in relation to the public welfare. A similar line of 
thought is suggested with reference to land values. Ten years 
ago we had about the same area and the same quality of land 
as we now have, so that its high value today cannot mean that 
we are better equipped with natural resources. 

We must be on our guard against attaching improper signifi- 
cance to estimates of total wealth. Changes in total value are 
not an accurate index of changes in well-being. It is possible 
that an increase in concrete material goods will actually decrease 
the total quantity of wealth measured in dollars. A hundred 
bushels of wheat at $1 per bushel have a higher selling value 
than two hundred bushels at 40 cents per bushel. If by some 
magical process all goods could be made free as air, there would 
be no value whatever. An estimate of the value of our stock of 
wealth also necessarily omits to take account of personal serv- 
ices. It is obvious also that per capita wealth has more 
significance for well-being than has total wealth. Individual 
wealth and value connote scarcity ; well-being implies abun- 
dance. Nevertheless, under present conditions, it is probable 
that an increase in per capita individual wealth, when not due 
to fluctuations in the value of money, also indicates an increase 
I 



114 OUTLINES OF ECONOMICS 

in well-being. There is no likelihood of our being able to in- 
crease the quantity of economic goods to such an extent as to 
render them free and hence valueless ; and, on the other hand, 
as will be more fully explained later, new wants are constantly 
developing, and value springs from the power to minister to 
unsatisfied wants. 

The national income is a concept which takes account of the 
services rendered directly by persons as well as of the material 
things that are used. The national income, objectively consid- 
ered, is a gigantic stream of food, clothes, comforts, personal serv- 
ices, etc., which is used up in the direct satisfaction of wants in a 
specified period, such as a year, by the millions of individual 
acts of consumption. Some writers would include also . the 
additions to our industrial equipment, such as new machines; 
but these may be regarded as promises of an enlarged future in- 
come of society, not as part of its present real income. Thus 
we may distinguish between the annual national product and the 
annual national income. 

It has been estimated that the average income per family 
was about $1500 in the United States in 1910.^ The margin of 
error in this average may be very great, but even if it could be 
taken as accurately measuring the per family income of that 
year, it would not necessarily be an index of how well we might 
live under some organization of society that attempted an equal 
or nearly equal distribution of income. The effect upon the 
efficiency of management, the hours of labor, and the intensity 
of effort might be disastrous. On the other hand, there might 
be much saving from an elimination of wasteful and unnecessary 
expenditure without a reduction of real enjoyment, and there 
might be a fuller utilization of productive forces now going 
to waste. We refrain from entering this realm of speculation. 

The national income may be looked upon as the national 
dividend, the sum total of good things to be divided among the 
various families or individuals. The forces determining the 
size of this dividend and the manner of its division are the 
main topics for discussion in political economy. 

1 W. I. King, The Wealth and Income of the People of the United States, Chap. ix. 



ELEMENTARY CONCEPTS II 5 

QUESTIONS AND EXERCISES 

1. Does the following statement agree with the definitions in the text? 
"The true basis for an estimate of a nation's wealth is to be found in the en- 
joyments of its members." Hadley, Economics, p. 4. 

2. Are the following wealth : air? whisky? a copyright? Lake Michigan? 
' skill as a carpenter ? good health ? 

3. Discuss the following: "Among the motives which lead men to 
accumulate wealth, the primacy, both in scope and intensity, therefore, 
continues to belong to this motive of pecuniary emulation." Veblen, 
Theory of the Leisure Class, p. 34. 

4. State the significance of the following : "A horse is not wealth to us if 
we cannot ride, nor a picture if we cannot see, nor can any noble thing be 
wealth except to a noble person." Ruskin, Munera Pulveris, p. 10. 

5. Discuss the following statement : "In 1770 Arthur Young reckoned the 
income of England to be £120,000,000; in 1901 the income may be roughly 
set down at £1,600,000,000. Making correct allowances for population 
and for prices, this growth of income would signify a large increase of com- 
modities per head ; but would it tell us that we are working and living some- 
what better than our ancestors?" Hobson, The Social Problem, p. 43. 

6. How does the Federal Income Tax law (as interpreted by the Treasury 
Department) define a person's income? 

REFERENCES 

Cannan, Edwest. Wealth, Chap. i. 

Clark, J. B. The Philosophy of Wealth, Chaps, i and iii. 

Ely, R. T. Property and Contract, Vol. i. Chap. iii. 

Fisher, Irving. The Nature of Capital and Income, Chaps, i and ii. 

Hadley, A. T. Econoinics, pp. i-io. 

Hobson, J. A. The Social Problem, Book i. Chap. ii. 

King, W. I. The Wealth and Income of the People of the United States, 

Chaps, ii and v. 
Leslie, T. E. C. Essays in Political Economy, Chap. i. 
Marshall, Alfred. Principles of Economics, 6th ed., Book ii. 
Mitchell, W. C. "Human Behavior and Economics: A Survey of 

Recent Literature," Quarterly Journal of Economics, Vol. xxix, pp. 1-47. 
PiGOU, A. C. Wealth and Welfare, Part i. Chaps, i and ii. 
RusKiN, John. Munera Pulveris, Chap. i. 

SiDGWiCK, Henry. The Principles of Political Economy, Book i. Chap. iii. 
Smart, William. Studies in Economics, Chap, viii ; and Distribution of 

Income, Book ii. 
Taussig, F. W. Principles of Economics, Vol. i. Chap. i. 
Veblen, Thorstein. The Theory of the Leisure Class, esp. pp. 24-34; and 

The Instinct of Workmanship, Chap. i. 
Special Census Reports on Wealth, Debt, and Taxation. 



CHAPTER VIII 
PRODUCTION 

Production Defined. — Man creates no new matter. Neither 
the farmer nor the merchant adds one atom to the existing 
material of the earth. Yet they are both properly called pro- 
ducers because they increase economic utility. Production, 
then, means the creation of economic utilities by the application 
of man's mental and physical powers to the materials of nature. 
The act of production can be reduced to the following thjree 
operations : (i) changing the form of things, or combining or 
rearranging them, (2) changing their place, and (3) keeping 
them until such times as they are wanted ; in other words, 
production adds to the materials of nature, form or composition 
utility, time utility, and place utility. Production thus defined 
includes the rendering of direct personal services. 

It has seemed to some that the farmer is more truly 
a producer than the manufacturer, and the manufacturer than 
the merchant; but such is not at all the case. All of these 
industrial classes help at some stage in the process of getting 
the materials of nature ready for consumption. The miner 
gets iron ore from the ground, the manufacturer transforms 
it into stoves, the railway company transports them, and the 
merchant acquires a stock of them and keeps them until they 
are wanted. One stage is as essential as another if wants for 
stoves are to be satisfied. It may well happen that the utilities 
produced by the merchant could be produced with a smaller 
expenditure of economic force, and that by a better organization 
of the factors of production saving could be effected ; but this 
is no justification whatever for the popular impression that he is 
not a productive worker. Things are not fully " produced " 
until they are in the form in which they are wanted, at the place 
at which they are wanted, and at the time when they are wanted. 

116 



PRODUCTION 117 

In books on political economy we are likely to find that much 
more is said about the distribution of wealth than specifically 
about its production. The reason for this is partly that the 
problems of production are to a very considerable extent a 
matter of technical progress. How to increase the yield per 
acre is not specifically an economic problem. Nevertheless 
the economist is interested in the volume of production compared 
with the growth in population and in changes in the character 
of production. Misdirected production is thought to have some- 
thing to do with economic crises, and changes in the production 
of gold may explain widespread changes in prices, so that 
production has in reality received a good deal of attention from 
economists in connection with their discussion of other sub- 
jects. In this book, for example, the relation of population to 
agriculture is considered in the chapter on Wages. 

The close relation between production and distribution may be 
further illustrated by the subject of " scientific management " 
in industry. This means such an arrangement of work, selection 
of methods, and measuring of individual efficiency within a 
factory or elsewhere as to produce the maximum output per 
man. Take the simple operation of shoveling coal or cinders, 
where this must be done by hand. It has been found that the 
amount handled per day per man will depend on the weight of 
the shovel, its size, the amount taken at each lift, and the number 
of movements per hour. The largest shovelful is not likely to 
be the most economical. Such inquiries obviously have a rela- 
tion to the wages which may equitably be paid to different 
workmen, and representatives of trade unions have looked upon 
the movement toward the utilization of scientific management 
with considerable suspicion and hostility as a system of driv- 
ing men to greater exertion. It would seem that if there is 
cooperation between managers and trade union officials, total 
production may be increased and wages may be increased by 
scientific management without detriment to the individual 
workingman. 

On the whole, it is probably true that the subject of production 
has in recent years been unduly neglected by economists. The 



Ii8 OUTLINES OF ECONOMICS 

conservation movement, looking toward the less wasteful utiliza- 
tion of our natural resources, had its origin outside of economic 
circles. In recent years, however, the economists are very 
properly placing more emphasis upon the obvious fact that 
economic progress depends upon increasing the annual per 
capita production of wealth as well as upon improving the way 
in which wealth is distributed among its producers. 

The Production of Values. — We have said that production 
means the increasing of economic utility. This is precisely 
equivalent to saying that it means the rendering of services 
that lead directly or indirectly to the satisfaction of human 
wants. And since we are not willing to pay for things that we 
do not want, it follows that every service for which we are 
willing to pay must be classed as productive. All money-mak- 
ing pursuits are, therefore, productive. Except through in- 
heritance or gift or gambling or fraud or theft one cannot gain 
an income unless one gives a quid pro quo by rendering productive 
services or by permitting the use of some productive agent 
which one owns or controls. But it does not follow that 
money-making is a measure or gauge of the amount of productive 
service rendered or that production and acquisition always go 
hand in hand. For the amount of money that will be paid for 
commodities and services will depend upon their value rather 
than upon their utility ; and scarcity, as well as utility, is a 
factor in determining the value of things. 

Men can sometimes increase the value of things by curtailing 
the supply of them, although, of course, this decreases their 
aggregate utility. In the case of a monopoly, where the power 
to control the supply of a product is lodged in the hands of a 
single producer or group of producers, this often becomes a 
matter of much importance. The case of the Dutch East 
India Company, which is said to have destroyed half of its 
spice crop, because the remaining half would have a greater 
value than the whole would have had, has been cited by many 
economists. In some fishing centers part of an unusually large 
catch is destroyed or sold as fertilizer in order that the market 
price may not be unduly lowered. Most commonly, of course, 



PRODUCTION 119 

limitation of supply is effected by merely producing less than 
might have been produced and sold at a price high enough 
to cover expenses. In competitive enterprises, however, no 
one producer can control the supply of the product, so that in 
general the only way in which a producer can increase the value 
of his output is by increasing its quantity and, consequently, 
its utility. But it should be clear that we may get very different 
results if we measure the results of productive effort in terms of 
values from what we should get if we used utility as our measure. 
From the point of view of social welfare, the production of 
utilities is, of course, what we are interested in. But we have 
to recognize that in our modern exchange economy the produc- 
tion of values is what producers are mainly interested in. In 
later chapters we shall have to consider more carefully the 
extent to which these two principles of production are in har- 
mony, and the ways in which they are in conflict. '^ 

Factors of Production. — It has been customary to speak of 
three factors of production — nature, labor, and capital. Under 
nature are included all forces external to man, as the wind, the 
movement of water, attraction of gravitation, cohesion, etc. 
Frequently these things furnished by nature are called simply 
land, because, of what belongs to external nature, it is with land 
that we have principally to do in political economy. 

Of the total land surface of the United States all but about 
15 per cent had been appropriated or reserved in 19 13. The 
unappropriated and unreserved portions were largely in Nevada, 
Arizona, Wyoming, and New Mexico. Of the total land sur- 
face, 46.2 per cent was in farms in 1910, and of these farms only 
54.4 per cent consisted of improved land; that is, only 25.1 
per cent of the total land area was improved farm land. " Im- 
proved farm land includes all land regularly tilled or mowed, 
land pastured and cropped in rotation, land lying fallow, land 
in gardens, orchards, vineyards, and nurseries, and land occupied 
by farm buildings." If all of the improved land were equally 

1 In a literal sense neither utility nor value is "produced." The things produced 
are commodities and ser^'ices, which have utility and value because they satisfy 
human wants that would otherwise be unsatisfied. 



I20 



OUTLINES OF ECONOMICS 



distributed, there would be about five acres for each person in 
the United States. This figure has decreased slightly in the 
last quarter of a century, although the historical comparison is 
made somewhat uncertain by the fact that woodland at the 
census of 1900, 1890, and 1870 was included in improved land, 
but was not so included in 1880 and 1910. The production of 
the leading cereals per acre has not changed much since 1890 
and on the whole the per capita production of wheat and corn 
measured in bushels has not increased since 1880. 

In other lines of production the per capita story is quite dif- 
ferent, as will be seen from the following table : 



Per Capita Production of Selected Commodities^ 
I 880-1 9 13 



Commodity 


1880 


1890 


1900 


1910. 


1913 


Per Capita 












Wheat production — bushels 


8.992 


7-732 


H-325 


7-352 


7.868 


Corn production — bushels . . . 


29.769 


29.483 


26.722 


30.341 


2?. 220 


Number of cattle on farms . . . 


.66,s 


.824 


.676 


.716 


•583 


Coal production — long tons . . 


1-378 


2.257 


3-I4S 


4.671 




Cotton production — 500 lb. bales 


.114 


.123 


.136 


.144 


.152 


Pig iron production — long tons . 


.074 


.129 


.192 


.266 


•319 


Ton-miles of freight 




1227 


1799 


2626 


3106 



Labor, as a factor of production, includes human activities of 
every sort, intellectual as well as physical, which have economic 
significance. We might better, perhaps, substitute man for 
labor as the second factor. Labor is supplied by human beings 
and is different from material goods because it is always con- 
nected with a personality. Moral and intellectual qualities 
increase its productiveness. Temperance, trustworthiness, 
skill, alertness, quick perception, a comprehensive mental grasp, 
— all these and other qualities belonging to the soul of man are 
of paramount importance. Man's mere physical strength in 
itself is a poor thing, being surpassed by that of the lower animals, 

1 Compiled from "Statistical Record of the Progress of the United States, 1800 to 
1913," in Statistical Abstract of the United States, 1913. Where possible, five-year 
averages have been used with the census year as the center. 



PRODUCTION 121 

but man is far more productive, and even as a slave sold for 
more than the lower animals. 

Man can get but little directly from nature with his unaided 
hands. The instruments which assist him, as we have seen, 
are called capital; in other words, capital is every product which 
is used or held for the purpose of producing or acquiring wealth. 
By this definition, land is evidently excluded from the category. 
The nation's capital, then, consists of tools, machinery, busi- 
ness buildings, transportation systems, raw material, etc.^ 
Capital cannot be looked upon as an independent factor of 
production, since it is derived from the labor of man applied to 
nature. This fact has led some persons to say that capital is 
simply stored-up labor, but this overlooks the important ele- 
ment of time required for production with the aid of capital. 
When we say that to print a book according to present-day 
methods requires the cooperation of labor and capital, we do 
not deny that the type-setting machines and printing presses 
which are used are themselves the product of other kinds of 
labor applied to nature. To substitute capital for labor may 
seem to be simply substituting one kind of labor for another. 
But a long time elapses between the digging of the iron ore and 
the actual using of the machines in printing, and this means 
waiting for results on the part of some one. Capitalistic produc- 
tion, as distinct from simple hand labor, is merely a different 
method — a roundabout method — of applying human labor 
to the materials of nature. It is this time element which gives 
rise to the problem of interest to be discussed in a later chapter. 

"Capital is an intermediate product of nature and labor, nothing more. 
Its own origin, its existence, its subsequent action, are nothing but stages in 
the continuous working of the true elements, nature and labor. They, and 
they alone, do everything from beginning to end in bringing consumption 
goods into existence. The only distinction is that sometimes they do it all 
at once, sometimes by several stages. In the latter case the completion of 
each stage is marked outwardly by the appearance of a fore-product or inter- 
mediate product, and capital has emerged. Put, let me ask, is a thing any 

^ We may here again caution the reader against confusing these concrete goods 
with their value. A factory building might sell for $100,000, but the capital is the 
building itself, not its money value. 



122 OUTLINES OF ECONOMICS 

the less the work of its author that it is not produced all at once, but in in- 
stallments? If today, by allying my labor with natural powers, I make 
bricks out of clay, and tomorrow, by allying my labor with natural gifts, 
I obtain lime, and the day after make mortar and so construct a wall, can it 
be said of any part of the wall that I and the natural powers have not made it ? 
Again, before a lengthy piece of work, such as the building of a house, is 
quite finished, it must naturally be at one time a fourth finished, then a half 
finished, then three quarters finished. What, now, would be said if one were 
to describe these inevitable stages of the work as independent requisites of 
house-building, and maintain that, for the building of a house, we require, 
besides building materials and labor, a quarter-finished house, a half- 
finished house, a three-quarters finished house? In form perhaps it is 
less striking, but in effect it is not a whit more correct, to elevate those 
intermediate steps in the progress of the work, which outwardly take the 
shape of capital, into an independent agent of production by the side of 
nature and labor." i 

For some purposes it is important to distinguish fixed capital, 
which lasts for a succession of operations, from circulating 
capital, which is used up in one act of production. Coal used 
in a locomotive is an example of circulating capital; the car 
in which the coal is hauled is fixed capital. The difference 
is one of degree only.^ 

Saving and Capital Formation. — From the individual stand- 
point, saving means the postponement of consumption. To 
lend to another, and thus secure a claim on his services for the 
future, is an act of individual saving, but this does not necessarily 
result in saving from the social standpoint. An act can be 
termed social saving only when the total social income in the 
future will be increased thereby. .It is conceivable that this 
might take the form of merely hoarding up finished consumption 
goods in anticipation of a famine, but that is not the kind of 
saving that is typical of modern industrial nations. It is true, 

1 Bohm-Bawerk, Positive Theory of Capital (trans, by W. Smart), p. g6. 

2 The difference between fixed and circulating capital has to be recognized in 
the accounting systems of business undertakings. Since the unit of time for which 
accounting attempts to state costs and profits accurately is usually a year, items of 
capital which are ordinarily acquired and disposed of ("turned over") within a 
year are called "current assets," while items of capital whose period of normal use 
is more than a year are called "capital assets." Both kinds of assets are, of course, 
capital in the economic sense, except that land is always included in "capital assets." 



PRODUCTION 123 

however, that we frequently produce durable consumption 
goods which will be used for a long time in the future. The 
construction of a public library building thus involves real 
social saving. 

But true social saving may also take the form of bettering 
the industrial equipment of society. To provide more and 
better machines it is necessary to use some of the labor which 
might be used to increase our present income. If all of the 
labor now used in the construction of new milling machinery, 
ovens, etc., were employed in turning into bread all of the 
flour we now have on hand, we could doubtless greatly increase 
temporarily our present income in bread, but it would be at the 
expense of the future income. Thus the saving which results 
in the formation of social capital requires two things: (i) 
abstaining from the largest possible income today, and (2) 
using part of our labor in bettering the industrial equipment. 

Organization of the Productive Factors. — The three factors, 
land, labor, and capital, must be brought together for purposes 
of production. In the case of many farmers and small-scale 
manufacturers, all three are furnished by the same person, but 
under our system of private property, a marked differentiation 
of ownership takes place as industrial development becomes 
more complex. In a large-scale establishment it is the ex- 
ceptional case where the majority of the laborers have any share 
in the ownership of the capital, but generally the owners of the 
capital are also the owners of the land. In American agri- 
culture, ownership of the land and the capital by the same person 
is also common, but in England at the present time it is the 
rule that the landowner and farmer are different persons. On 
the other hand, factories are frequently built upon leased ground, 
and much land is farmed in America by tenants who furnish 
their own capital. Separation in the ownership of the produc- 
tive factors makes necessary a distinct valuation of the services 
of each one of the factors. 

The Entrepreneur, or Undertaker. — The one who manages a 
business for himself was formerly called an undertaker, or ad- 
venturer, but the first word has been appropriated by one small 



124 OUTLINES OF ECONOMICS 

class of business men, and the latter has acquired a new mean- 
ing, carrying with it the implication of rashness and even 
dishonesty. We have consequently been obliged to resort to 
the French language for a word to designate the person who 
organizes and directs the productive factors, and we call such a 
one an entrepreneur. The entrepreneur also assumes a large 
measure of business risks and uncertainties. 

The function of the entrepreneur has become such an im- 
portant one in modern society that it is often convenient to 
regard him as a fourth factor in production, distinct from other 
classes of laborers. He has been well called a captain of in- 
dustry, for he commands the industrial forces, and upon him 
more than any one else rests the responsibility of success or 
failure. A business which has achieved magnificent success 
often becomes bankrupt when, owing to death or other causes, 
an unfortunate change in the entrepreneur is made. ■ The 
prosperity of an entire town has sometimes been observed to 
depend upon half a dozen shrewd captains of industry. 

Division of Labor. — A characteristic feature of the organiza- 
tion of the factors is what is commonly called a division of labor, 
but this term suggests a number of related ideas which must be 
distinguished, (i) We may mention first a separation of occupa- 
tions, each one being independent of the other, as is shown, for 
example, in the splitting up of medical work into various special- 
ties, and again, entirely new occupations are continually appear- 
ing. (2) We also find production divided into stages, each 
one giving rise to a commercial product, but not to a finished con- 
sumption good. This becomes clear if we think of the history 
of almost any article of daily use : the making of bread pre- 
supposes the flour and wheat stages. (3) We have in the third 
place what is most commonly referred to by the term " division 
of labor," where the productive process is divided into minute 
parts, and one part given to each laborer. The' organization 
of a cotton mill affords an excellent illustration : 

In cotton mills, as in all other textile mills, there are men of skill and ex- 
perience who superintend or oversee the work in various buildings and in 
the rooms and yards. These supervisory employees have assistants, and 



PRODUCTION 125 

the division of superintendence is carried down to the sections of rooms, so 
that all sections have their supervisors, known variously as section bosses, 
section hands, section girls, and third hands. The following list of occupa- 
tions will indicate the extent to which division of labor is carried in this 
industry : alley boys (or girls) ; bundle boys ; filling and roving carriers ; 
belt makers, blacksmiths, carpenters, machinists, masons, painters, steam 
fitters, and other mechanics, including sometimes electricians and battery- 
men ; roll coverers ; helpers ; laborers (unskilled) ; bale openers ; picker 
hands or cotton shakers ; lap tenders ; card brushers ; first and second 
breaker hands; finisher pickers; card boys; card hands; waste hands; 
wastemen ; card clothiers ; card strippers ; card grinders ; combers ; lap- 
head hands ; doublers ; drawing-frame tenders ; railway-head tenders ; slub- 
bers ; speeders, fly-frame tenders ; jack tenders ; rovers ; spinners ; bobbin 
boys; yarn pourers; piecer and doffer; back boy; band boys; doublers 
and twisters ; winders ; yarn untanglers ; spool boys, white spoolers ; warp- 
ers; slasher tenders; size makers; reel hands; dye-house hands (with 
further subdivisions) ; beamers and splitters ; beam carriers ; warp drawers ; 
harness menders; harness brushers; handers-in; twisters-in; loom fiLxer; 
pattern makers ; putters-up of samples ; cloth weavers ; weavers of designs ; 
yarn carriers ; smash piecers ; spare weavers ; inspectors ; trimmers. The 
finishing of the cloth is a separate industry.^ 

This form of the divison of labor may also exist without the 
use of complex machinery, as in the slaughtering and meat- 
packing industry. 

"It would be difficult to find another industry where division of labor has 
been so ingeniously and microscopically worked out. The animal has been 
surveyed and laid off like a map ; and the men have been classified in over 
thirty specialties and twenty rates of pay from 16 cents to 50 cents an hour. 
The 50-cent man is restricted to using the knife on the most delicate parts of 
the hide (floorman) or to using the ax in splitting the backbone (splitter) ; 
and wherever a less skilled man can be shpped in at 18 cents, i8§ cents, 20 
cents, 21 cents, 22^ cents, 24 cents, 25 cents, and so on, a place is made for 
him and an occupation mapped out. In working on the hide alone there are 
nine positions at eight different rates of pay. A 20-cent man pulls off the 
tail, a 2 2§ cent man pounds off^ another part where the hide separates readily, 
and the knife of the 40-cent man cuts a different texture and has a different 
'feel' from that of the 50-cent man. Skill has become specialized to fit the 
anatomy." ^ 

1 From the Glossary of Occupations in the volume on Employees and Wages. 
Twelfth Census, Special Reports, igo3. 

^ Commons, Trade Unionism and Labor Problems, p. 224, in a chapter appearing 
originally in the Quarterly Journal of Economics, vol. xix, p. i. 



126 OUTLINES OF ECONOMICS 

Advantages of Division of Labor. — The advantages of a 
division of labor have been enumerated as follows : (i) A gain 
of time. A change of operations costs time. Less time is 
also consumed in learning one's business, as the labor of each is 
more simple. (2) Greater skill is acquired, because each person 
confines himself to one operation. (3) Labor is used more 
advantageously. Some parts of an industrial process can be 
performed by a weak person, others require unusual physical 
strength; some require extraordinary intelligence, some can 
be performed by a man of very ordinary intellectual powers. 
Special capacities are best utilized, and work is found for all, 
young and old, weak and strong, stupid and intelligent. (4) 
Inventions are more frequent, because the industrial processes 
are so divided that it is easy to see just where an improvement 
is possible. Besides this, when a person is exclusively engaged 
in one simple operation, he often sees how the appliances he 
uses could be improved. Workmen have made many important 
inventions. (5) Capital is better utilized. Each workman uses 
one set of tools, or one part of a set, and keeps that employed 
all the time. When each workman does many things, he has 
many tools, and some are always idle. (6) Finally, where the 
division of labor results in the simplification of operations, it 
facilitates the substitution of machinery with mechanical 
power in place of direct human labor. It would, for example, 
probably be impracticable to make a machine which would 
directly convert leather into finished shoes. But it has been 
found a relatively simple matter to devise machines which will 
successfully accomplish each of the successive steps in shoe- 
making. Such a subdivision and simplification of manufacturing 
processes is only possible when they are conducted on a large 
scale. " It is the largeness of markets, the increased demand 
for great numbers of things of the same kind, and in some cases 
of things made with great accuracy, that leads to subdivision of 
labor; the chief effect of the improvement of machinery is to 
cheapen and make more accurate the work which would any- 
how have been subdivided." ^ 

1 Marshall, Principles of Economics, 6th ed., p. 255. 



PRODUCTION 127 

Effects upon the Worker. — The effect of the introduction of 
machinery upon wages will be discussed in a later chapter, but 
here some attention must be given to the effect of division of 
labor and machinery upon the life of the worker. It is fre- 
quently said that when labor is rendered simple it loses both its 
attractiveness and its educational value. A man can enjoy his 
work when he manufactures a whole watch, bearing the impress 
of care and skill, but who can like the mere routine of feeding 
material into some machine? A workingman becomes a mere 
cog in a great mechanism, driven at a certain speed, day after 
day, with no further interest in the result of his labor than that 
it is the source of his daily wage. But much may be said on the 
other side. To a large extent the heaviest labor is done with 
mechanical appliances, and those movements which are very 
simple and regular are precisely the ones which are likely to be 
taken over by machinery, leaving to human beings the work 
which requires intelligence and skill. 

"Looked at broadly, is the average work of a laborer in a machine industry 
less dignified, less agreeable, less humanizing than it was before the industry 
reached the machine stage ? From the nature of the question, it is danger- 
ous to dogmatize, because neither the affirmative nor the negative is capable 
of being demonstrated. The negative view seems to rest mainly upon the 
assumption that it is more dignified to be occupied with a great many purely 
mechanical operations than with a very few. The old-fashioned shoe- 
maker, for example, was largely occupied with purely mechanical opera- 
tions, most of them of a very elementary nature, such as a machine can do 
quite as well as a man. Each of these operations required great concen- 
tration of attention, leaving him very little opportunity for other forms of 
mental activity. He was the slave of each particular task as truly as a 
modern machine worker can be said to be the slave of his single task. But 
the old-fashioned shoemaker had to turn from one kind of work to another. 
This increased the difficulty, and, on the whole, required of him a greater 
amoimt of concentration than is now required of the operator of a machine. 
The latter, who has but one routine task to learn, learns it easily, and can 
carry it out without very intense concentration of mind. His mind, there- 
fore, would seem to be freer than that of the old hand worker, though there 
was more variety to the work of the latter. Whether this greater variety 
is to his advantage or disadvantage would be difficult to determine off- 
hand. It looks as though the operator of a machine in a shoe factory, 
being relieved of the necessity of acquiring several forms of specialized 



128 OUTLINES OF ECONOMICS 

manual dexterity, would be in a better position for free mental activity than 
the old-fashioned shoemaker." ^ 

It seems that those who declaim against factory Kfe do not 
always distinguish those things which are temporary from 
things which are inherent in the system. Long hours, insanitary 
conditions of work, and frequent industrial accidents need not 
be inevitable accompaniments of the use of machinery. It is 
the efficiency of machine methods that makes leisure possible 
for the workingmen, and when they learn to use that leisure 
sanely, their condition will be far in advance of what it could 
be under more primitive methods of production. 

The charge is also brought against machine production that it 
is antagonistic to the development of art. Machine production 
means uniform production. It is possible that a growth in the 
desire for what is beautiful rather than cheap will limit the use 
of machinery in some directions {e.g. we may insist upon more 
hand work in the making of furniture), but an extensive use of 
machinery as a servant of art will always be necessary, and 
that in two ways : (i) For an appreciation of art there must be 
leisure, or at least leisurely work, and without machine methods 
this is not possible for the masses. (2) There is much work that 
is preliminary to the work of the artist, and that can be done by 
machinery. Will a building be less artistic because much of the 
heavy work of dressing the stone is done by machinery ? Taken 
as a whole, however, we have probably been too much inclined 
to view progress as something that causes tons per capita to 
increase by leaps and bounds, rather than as something that 
improves the quality of our enjoyments. 

Territorial Division of Labor. — The concentration of a certain 
industry in a particular region is often called the territorial 
division of labor, or the localization of industry. Illustrations 
are seen in the prominence of the boot and shoe industry in 
Massachusetts ; the collar and cuff manufacture in Troy, New 
York ; oyster canning in Baltimore ; the manufacture of gloves 
in Gloversville and Johnstown, New York ; of coke in the Con- 

^T. N. Carver, "Machinery and the Laborers," Quarterly Journal of Economics, 
vol. xxii, p. 230. 



PRODUCTION 



129 



nellsville district, Pennsylvania; of brassware in Waterbury, 
Connecticut ; of carpets in Philadelphia ; of jewelry in Provi- 
dence, Rhode Island, and Attleboro and North Attleboro, Massa- 
chusetts ; slaughtering and meat packing in Chicago ; the man- 
ufacture of plated and britannia ware in Meriden, Connecticut ; 
and of silk in Paterson, New Jersey. The following causes 
of localization have been mentioned : (i) proximity to raw 
material, (2) accessibility of markets, (3) presence of water 
power, (4) favorable climate, (5) availability of labor, (6) 
availability of capital, and (7) the momentum of an early start. 
The explanation of how these causes have operated in particular 
instances is left as an exercise for the student.^ 

Productive Organization of the American People. — Accord- 
ing to the Census of 19 10 about two fifths of the total population 
and about one half of the population ten years of age and over 
are engaged in gainful occupations. In the following table 
the extent to which persons in each age group are gainfully em- 
ployed is shown for each sex : 

TABLE I 

Number and Percentage Engaged in Gainful Occupations for Spec- 
ified Age Groups of Males and Females : 1910 ^ 





Males of SpEciriED Age 


Females of Specified Age 


Age 


Number 


Engaged in Gainful 
Occupations 


Number 


Engaged in Gain- 
ful Occupations 




Number 


Per 

Cent 


Number 


Per 

Cent 


10-13 years 
14-15 years 
16-20 years 
21-44 years ^ 
45 years and 
over . . 


3,665,779 
1,798,449 

4,564,179 
17,848,843 

9,149,308 


609,030 

744,109 

3,615,623 

17,262,209 

7,860,593 


16.6 
41.4 
79.2 
96.7 

85-9 


3,593,239 

1,770,898 

4,632,821 

16,331,449 

8,224,305 


286,946 

350,140 

1,847,600 

4,302,969 

1,288,117 


8.0 
19.8 

39-9 
26.3 

15-7 


10 years and 
over . . 


37,027,559 


30,091,564 


81.3 


34,552,712 


8,075,772 


234 



1 Consult Hall, "The Localization of Industry," Census Bulletin No. 244 (also 
found in Twelfth Census, Manufactures, Part i, p. cxc), and Ross, "The Locali- 
zation of Industry," Quarterly Journal of Economics, vol. x, p. 247. Also the 
Federal Census of Manufactures for 1905, vol. i, Chap. xii. 

2 Thirteenth Census, vol. iv, p. 69. ^ Includes persons of unknown age. 



I30 



OUTLINES OF ECONOMICS 



The following table shows the distribution of the gainful 
workers among the five main classes of occupations. The most 
striking facts are the decline in the relative importance of agri- 
cultural pursuits and the increase in the relative importance of 
trade and transportation. 

TABLE II 

Distribution by Main Classes of Persons Engaged in Gainful Occu- 
pations 



Class of Occupation 


1910 


1900 


1890 


1880 


Agricultural pursuits 

Professional service 

Domestic and personal service . . 
Trade and transportation .... 
Manufacturing and mechanical pursuits 


32.9 

4.8 

14.0 

19.9 

28.3 


35-7 
4-3 
19.2 
16.4 
24.4 


39-2 

4.0 

18.1 

14-3 

24.4 


44-3 
3-5 
L9.6 
10.8 
21.8 


AU occupations 


100. 


100. 


100. 


. lOO.O 



The broad territorial division of labor is seen when these per- 
centages are given separately for groups of states : 

TABLE III 

Percentage Distribution of Persons 10 Years of Age and Over En- 
gaged IN Gainful Occupations, by Geographic Divisions: 1910^ 



Division 



New England . . 
Middle Atlantic 
East North Central 
West North Central 
South Atlantic . . 
East South Central 
West South Central 
Mountain . . . 

Pacific 

United States . . 









25 


2: 









^ 
















a 





H 



< 

< 


< 






w & H 

1-1 -ST! 
« 2 " 


1 


fe 2; 5 
a « 



< 


S 




H 


33 
(1< 


CM 


Q^ 


10.4 


0-3 


49.1 


6.5 


10.6 


1-7 


4.8 


10.7 


lO.O 


4.2 


40.6 


8.0 


12.0 


1.4 


4.9 


11.8 


25.6 


2.6 


33-2 


7.6 


10.6 


I.I 


4.8 


9.2 


41.2 


1.8 


20.0 


7.8 


10.4 


I.I 


5-2 


8..S 


51-4 


1.8 


18.6 


S-o 


6.1 


I.O 


3-0 


lo.s 


63.2 


1.9 


12.4 


4.0 


5-3 


o.b 


2.6 


8.4 


60.1 


0.7 


12.6 


5-2 


7.0 


0.8 


3-3 


8.1 


32.4 


9.4 


I9-S 


10.3 


8.7 


1-7 


5-2 


9-1 


22.6 


2.4 


27.2 


10.3 


12.6 


2.0 


6.0 


"•3 


33-2 


2-5 


27.9 


6.9 


9-5 


1.2 


4.4 


9.9 



►J o 



1 Thirteenth Census, vol. iv, p. 45. 



PRODUCTION 131 

QUESTIONS 

1 . Is the employee in a planing mill in a worse position than the old-time 
carpenter who has to do his planing by hand ? 

2. Is the keeper of a gambling establishment a producer of wealth? 

3. Is an insurance agent a producer of wealth? 

4. What would happen if there should be too much saving? 

5. Why is Massachusetts the center of the boot and shoe industry? 

6. Write a survey of national resources and production in the United 
States from data in the Statistical Abstract of the United States. 

REFERENCES 

Ely, R. T. Property and Contract, Vol. ii, Appendix iii. 

Fisher, Irving. The Nature of Capital and Income, Chaps, v and vi. 

HoBSON, J. A. The Social Problem, Book ii. Chap, ii ; and Work and Wealth, 

Chaps, iv-viii. 
Marshall, Alfred. Principles of Economics, 6th ed.. Book iv. 
National Conservation Commission, Report (1909). 
Thirteenth Census, Reports. 
Statistical Abstract of the United States (annual). 
Taussig, F. W. Principles of Economics, Vol. i, Chaps, ii-v. 
Van Hise, C. R. Conservation of Natural Resources in the United States. 
Veblen, Thorstein. The Theory of Business Enterprise, Chaps, ii and iii. 



CHAPTER IX 
CONSUMPTION 

Consumption Defined. — Consumption means, in economics, 

the use of goods in the satisfaction of human wants, directly or 
indirectly. It is the chief incentive to economic activity, but 
it is not the sole incentive, for such activity is to a certain extent 
an end in itself. Nevertheless, in economic society as it is 
organized to-day we are justified in looking upon the consumption 
of material goods in the satisfaction of human wants as the 
essential motive and purpose of the production of such goods. 
Wants are so far from satisfied that most men must work, not 
because of the pleasure they may derive from the exercise of 
their capacities, or to utilize fully their natural energies of 
brain or muscle, but because they need or crave the goods 
which their wages will buy. Regarded as an incentive to 
economic activity, consumption should, of course, be defined 
so as to include the use made of direct personal services as well 
as of material goods. 

The philosophy of the consumption of wealth falls only partly 
within the domain of economics, for the use of wealth is a large 
part of the problem of life. Passing judgment on the rational 
standards according to which the true importance of different 
wants should be measured does not directly concern us in the 
study of economics. 

Productive and Final Consumption. — When used without 
qualification, the word " consumption " in economics is com- 
monly taken to refer to the use of goods or services to satisfy 
wants directly. But some goods, such as machines and raw- 
materials, are used up in the production of other goods. This 
we may call productive consumption, while that consumption 
which results directly in the satisfaction of wants is final con- 
sumption. It is now less necessary than it was in the days of 

132 



CONSUMPTION 133 

Carlyle and Ruskin to insist that food consumed by laborers 
is not productive consumption. It is true that some analogy 
lies between the consumption of fuel by an engine and the con- 
sumption of food by a worker, but there is the very important 
difference, that the engine is specifically adapted to render 
economic service and cannot be conceived to derive any benefit 
whatever from its consumption of fuel, while in the case of the 
worker the consumption of food is determined with primary 
reference to his natural appetites and individual welfare. Man 
is our final term. 

Human Wants. — In the study of human wants as a starting 
point in economic theory, two facts stand out prominently : the 
expansion in the number and variety of wants, and the satiability 
of any particular one of them. As man has progressed from 
savagery to civilization, the variety of things he desires and even 
considers necessary to his existence has expanded enormously. 
His interests become more varied, his capacity to enjoy becomes 
larger, and he lives a fuller and more complex existence. There 
are indeed those who would have us " return to nature " and 
live a simple life, but taking the world as it is, the expansion of 
human desires with passing time appears to be without limit. 

But when we turn to consider some specific want by itself, as 
it is at any particular time, the matter is different. Our nerves 
weary of a repeated stimulus, and any attempt to continue 
indefinitely the enjoyment of some sensation results in satiation. 
A phonograph record grows stale after a number of repetitions. 
An apple has differing degrees of utility for any one of us, vary- 
ing from the highest degree, if we are on the point of starvation, 
to disgust, if a considerable number have just been consumed. 

Law of Diminishing Utility. — The fact that the intensity of 
our desire for additional units of a commodity decreases as we 
acquire successive units is of fundamental importance in economic 
science. And this " law of diminishing utility," as it is called, 
rests upon a broader basis of human experience than the mere 
satiability of the appetite for a particular kind of food, or the 
growing weariness of the nerves under the repetition of a partic- 
ular stimulus. The truth is that most commodities serve a 



134 OUTLINES OF ECONOMICS 

multitude of different needs and different purposes, and that 
these needs and purposes vary greatly in their importance. It 
is better to have two suits of clothes than to have one, but it is 
by no means twice as important. And a third, or a fourth, 
or a tenth suit, are, in order, of rapidly decreasing importance. 
How large shall my building lot be? How many rooms shall 
I have in my house? How much electric current shall I use 
for lighting purposes? How many motor cars shall I own? 
How many servants shall I employ? Questions such as these 
at once suggest the way in which a certain minimum amount of 
a given commodity or of a given service may be deemed ex- 
ceedingly important for our purposes, and how a diminishing 
importance is attached to successive additional portions or 
increments. So far as any one commodity is concerned it is 
in general less important to have more than to have some. 

To guard against possible misunderstanding a word of caution 
is necessary at this point. With passing time the use of a partic- 
ular commodity often cultivates a taste for it, so that an increased 
supply is more urgently desired than were the earlier increments. 
Thus familiarity with good books or good pictures or good 
music may increase the pleasure that we find in such things, and 
so may intensify our desire to have more. And bad habits, 
like good ones, are prone to " grow on us." Such, for example, 
is the case in the use of habit-forming drugs. But these facts 
do not contradict the law of diminishing utility. For that law 
relates only to the consumer as he is at any given time, with 
whatever possessions, habits, desires, and aversions are his at 
that time. Men change and their wants change, and the 
character of a man's consumption is, of course, a very important 
factor in changing his wants. But just now we are considering 
men as potential buyers of more goods or sellers of surplus goods 
in a given market at a given time, and for men so considered 
the law of diminishing utility expresses a fundamental truth of 
very great significance. 

A thoughtful reader may object that in view of the considerations urged 
in the preceding paragraph such illustrations as that of the satiety resulting 
from eating a number of apples are not exactly to the point, for when the 



CONSUMPTION 135 

hungry eater of apples becomes a satiated eater of apples, he is, in that 
respect, a "changed person." It is true that some expositions of the prin- 
ciple of diminishing utiHty attach altogether too much importance to what 
have been called "dinner-table illustrations." But the real point in the 
matter is that the satiation of the appetite is a famihar fact of experience, 
which has an important bearing upon the character of our wants as they 
manifest themselves at any one time. If I am hungry, but have six apples, 
I will give less for another apple than if I had only one. 

Marginal Utility. — It must be evident, therefore, that to 
say that a certain thing possesses utiHty is very indefinite. That 
merely tells us that it is capable of satisfying some want, per- 
haps important, perhaps unimportant. And, furthermore, 
one may use some units of a commodity in the satisfaction of 
very important wants, and other units of the same commodity 
in the satisfaction of relatively unimportant wants. This 
amounts to saying that for any one person different units of 
the same commodity may possess very different degrees of 
utility. The utility of the final or marginal unit of a person's 
stock of a given commodity is called the marginal utility of that 
commodity to that person. If, for example, a boy has six apples, 
the marginal utility of apples to him is simply the utility (or 
want-satisfying capacity) of the sixth apple. This does not 
mean the utility of any particular apple, but does mean (if the 
apples are all alike) the utilit}^ dependent on the possession of 
any one apple of his stock of six. This will be less than if he 
had fewer apples, and more than if he had a larger number. 
So with a householder who has a stock of ten tons of coal for 
his winter's supply. The tenth ton (any one ton of the ten) 
is the marginal ton ; and the utility it adds is the marginal utility 
of coal to the householder. Marginal utility thus depends upon 
the intensity of the want dependent for its satisfaction upon the 
possession of one unit of a commodity. The larger one's supply 
of a commodity, the smaller in general will be the importance 
one attaches to the possession of any one unit of the supply. 

Some writers prefer to define marginal utility as the utility of an addi- 
tional unit of a commodity rather than as the utihty of the last unit of one's 
present stock. In some apphcations of economic analysis it is convenient 
to think of the successive units or increments in the supply of a commodity 



136 



OUTLINES OF ECONOMICS 



as indefinitely small. In this case the difference beween the "last unit" 
and an "additional" unit becomes negligible. But for many purposes it is 
more convenient to think of the size of our successive increments as being 
that of the ordinary units in which goods are customarily bought and 
sold. ' In such cases whether the "last unit" or the "additional unit" should 
be considered the marginal unit depends upon whether we think of the 
individual concerned as a possible seller or a possible buyer. If the boy 
with the apples is weighing the desirability of having yet another apple 
against that of some peanuts he would have to part with in exchange for 
it, the marginal utility of apples to him may properly be said to be the 
utility of the additional apple, for this is the basis of its subjective impor- 
tance for the purpose in hand. But if he is contemplating the exchange of 
an apple for additional peanuts the marginal utility of apples to him depends 
upon the importance of the sixth apple. It is always accurate to identify 
marginal utility with the utility of the last unit of a stock, if we remember 
that in some cases it is the last unit of an existing stock and in other cases 
the last unit of a (possibly) increased stock. 



Marginal Utility Illustrated. — A clearer notion of marginal 
utility may be given with the help of Figure i, following. We 

take for our illustration 
the consumption of water, 
which has numerous uses 
of various degrees of im- 
portance. We have marked 
off different portions of the 
base line representing quan- 
tities of water available for 
man's use. The first quan- 
tity, ah, is just enough for 
drinking purposes. Sup- 
pose this is all the water 
to be had. There will be no question of sprinkling lawns or 
even of bathing under such circumstances. What will be the 
utility of water? Evidently the extent of the service which 
it renders us, and as this is the preservation of our life we cannot 
estimate it. We will indicate it by the area above the line ah 
which runs upward indefinitely as the curved line fails to close 
in. What will be the importance of another portion of water 
at this point of supply? As this additional portion which we 




CONSUMPTION 137 

desire is not needed for drinking but for a less important pur- 
pose, the marginal utility of the water will now depend upon 
the urgency of this less-important want. Now suppose we 
have three portions of water, represented by the lines ah, 
be, and cd. We now have enough for all our wants, down 
to sprinkling the lawn and the street. We are willing to 
pay something for more water for this purpose, but how 
much ? As much as when we had only water enough to drink ? 
By no means. The next want on our list is comparatively 
unimportant, and of course we appraise an increased supply 
accordingly. With two or three more portions of water all 
our wants are satisfied, and the marginal utility of water 
will have become zero. As the amount of water is increased, 
the utility falls according to the curved line hi, till finally it 
touches the base line, where the marginal utility of the water 
vanishes. 

Subjective Value. — As we proceed in our study we shall see 
that the most important problem of economics is that of as- 
certaining the laws which determine the prices of different goods 
and services. To some goods and some services more impor- 
tance is attached than to others, and larger quantities of the less 
important goods and services can be obtained in exchange for 
smaller quantities of the more important goods and services. 
This is a matter of prime significance, since it determines the 
way in which the different persons who contribute goods and 
services to the aggregate wealth-product of the community will 
be able to secure shares in it. 

We are not yet ready to attack the general problems of value, 
but we can take an important step forward at this point by 
grasping the meaning of subjective value. 

The subjective value of a good is not, of course, a definitely 
measurable objective quality of the good, like weight or exten- 
sion. It is, as the word " subjective " implies, purely psycholog- 
ical, and may be different for different persons. It is, moreover, 
purely relative. The subjective valuation of things always 
implies the choosing of some things rather than others. In 
other words, it involves a determination of their comparative 



138 OUTLINES OF ECONOMICS 

importance for one's own purposes. More formally stated, the 
subjective value of a good to any person is that person's estimate of 
the importance of possessing that good as compared with the im- 
portance of possessing other goods. 

But we do not value things in the abstract, or in indefinite 
quantities. In buying coal or sugar or oranges we do not have 
to confront the alternatives of either doing entirely without such 
commodities or acquiring an indefinitely large supply. If we 
decide to buy at all, we may buy as little as we please. Our 
choices, in practice, resolve themselves into questions of more 
or less. Even in the case of an indivisible good — an auto- 
mobile, for example — one may choose between having more or 
less of certain desirable qualities, such as size, or power, or 
attractive finish. And it is evident that whether the importance 
that we attach to the possession of an additional unit of a cer- 
tain good is greater or less than the importance that we attach 
to an additional unit of some other good will depend, very 
largely, upon the extent to which our wants for each of the 
goods in question are satisfied without the possession of the 
additional unit. Put in other words, the question is : Which 
good has the higher marginal utility? 

Subjective value, then, involves a balancing or comparison 
of marginal utilities. In fact, we may say that the subjective 
value of a good is the expression of its relative marginal utility. In 
this statement the word relative is used in order to emphasize 
the element of comparison or choice. / 

The Subjective Value of a Stock of Goods. — It shouid be 
carefully noted that marginal utility tells us nothing about the 
total subjective value of one's whole stock of the commodity. 
It refers solely to the present value of an additional unit, or 
the sacrifice that would be occasioned by the loss of a unit. We 
cannot get the total subjective value of a stock of goods by mul- 
tiplying the marginal utility by the number of units, even though 
they be all alike. The very term " marginal " tells us that the 
conception implies successive additions, and the present im- 
portance of one unit tells us nothing definite about the im- 
portance of the other units. If we wish to ascertain the total 



CONSUMPTION 



139 



subjective value of a stock of a commodity, we have simply to 
treat it as one large unit, and ask what would be lost if it were 
taken away. By this test all air would be found to have an 
immeasurable utility, at the same time that the subjective value 
of an additional cubic foot would be nothing. Thus it will be 
seen that the cause of subjective value is utility under a condi- 
tion of scarcity ; that is, such a limitation of the supply that not 
all wants can be satisfied. 

The Economic Order of Consumption. — What has been said 
regarding the way in which our individual estimates of the im- 
portance of a commodity are determined will help to explain 
how we make our choices in attempting to obtain the largest 



la 



lb 



Ic 



Id 



le 



2. a 






21) 






2c 






2d 




2e 



Fig. 2 



Fig. 3 



amount of satisfaction with the income at our disposal. Evi- 
dently we must spend each succeeding dollar for purchasing that 
commodity of which a dollar'^s worth will give the greatest 
satisfaction. Let Figures 2 and 3 show the declining impor- 
tance of two commodities which an individual is consuming, and 
suppose that each unit of each commodity costs one dollar. If 
the individual has ten dollars to spend upon these two commodi- 
ties, his order of consumption will be as follows : he would begin 
with 2a, but another unit of commodity 2 would give him less 
satisfaction than a unit of commodity i. Hence, his consump- 
tion will continue as follows : 

la, 26, 2C, ih, IC, id, 2d, 26, le. 



140 



OUTLINES OF ECONOMICS 



In this illustration it was assumed that a unit of each com- 
modity had the same cost. In this case, the unit consumed is 
always the one that has the largest utility. But where the 
cost of the units is different, cost must be considered also, 
and we commonly do so by asking ourselves whether the thing 
we are buying is worth as much as other things which could be 
obtained with the same expenditure. Thus we are constantly 
abstaining from the further consumption of one thing, not 
because our wants for it are fully satisfied, but because some- 
thing else of equal cost appears at that moment to be more 
important. 

Future "Wants. — Not all of the goods for which we strive are 
wanted for present consumption. We recognize that we shall 



\ 

la 


\ 

lb 


\ 

Ic 


\ 

Id 


\ 

le 



Sh 



2d 



2e ^ 



Fig. 



Fig. s 



have needs next month or next year, and we attempt to make 
some preparation for them. These future needs, it is true, 
usually appeal to us less vividly than if they were present, but 
we attach a present importance to them and grade them, and 
they enter into our calculations when we spend money, modifying 
the order of our consumption. This will be seen from Figures 
4 and 5. Let us suppose that in Figure 4, a, b, c, d, e represent 
the diminishing importance of successive units of a commodity 
for present consumption, and that Figure 5 shows the present 
importance attached to the future consumption of similar units. 
Then an individual would consume la, i.e. in the present. 
But a second unit for present use would rank lower in present 
esteem than a unit saved for future use. The unit 2a would 



CONSUMPTION 141 

then be saved, and then the order would be as follows : ib, 
2b, ic, etc. Thus this individual has saved two out of five 
units, i.e. 2a and 2b, with the same sort of, mental calcula- 
tion as he would use in deciding to spend a nickel for a 
peach rather than for a pear. But if some one should ask him 
to spend his fifth dollar for 2c instead of for ic, he would require 
some extra inducement to induce him to postpone at ruHng 
prices. It thus appears that a certain amount of saving is done 
without payment, but if saving is to be carried beyond a certain 
point, it must be given some special premium or compensation. 
This, as we shall see later, has a very important bearing upon 
the problem of interest. 

The Margin of Consumption. — Either by a conscious balancing against 
each other of the pleasures to be obtained from two or more possible pur- 
chases, or oftener, by simply buying the things which we want more than we 
want other things, we tend to keep our unsatisfied wants in a state of ap- 
proximately equal intensity. We apportion our expenditures so that our 
money will "go as far as possible"; that is, so that it will provide those 
things that have the strongest present appeal to us. Every person thus has a 
margin of consumption, which is measured by the utility obtained in return 
for the final or marginal dollar expended for any one of the things that he 
consumes. If he unwisely expends too much for any one thing, his more 
important unsatisfied wants for other things press upon him urgently, and 
he is apt to try to restore the balance or equilibrium in his expenditures, 
or, in other words, to bring his margin of consumption into alignment. 

An individual's margin of consumption depends primarily on his income, 
but also on his tastes and habits, his disposition to save, and the relative 
emphasis which he places upon his present and his future wants. Then, 
too, one's desires are constantly changing under the influence of whim, 
fashion, satiety, sellers' advertising, education, travel, reading, and new 
experiences of all kinds. Expenditures of all kinds are thus called into 
being by the necessity of maintaining the level of the margin of consumption. 

The margin of consumption is different for different persons. This is 
partly a matter of differences in individual tastes and purposes, but it is 
more largely a matter of differences in incomes. The larger one's income, 
the lower, of course, is one's margin of consumption, in the sense that one 
is able to acquire goods in larger quantities and thus to satisfy wants of 
less urgency. And, of course, a larger variety of commodities can be con- 
sumed, so that as one's income increases one's margin of consumption is 
normally extended downward and outward, including more things, but things 
of less importance. 



142 OUTLINES OF ECONOMICS 

Consumption and Saving. — It is difficult to say just where 
consumption should stop and saving begin, to secure the best 
results for society as a whole, but the principle is clear. So 
much, and only so much, should be saved as will conduce to a 
maximum total service over long periods of time. The present 
generation might deny itself everything except the barest neces- 
sities, and labor to increase the productive equipment to be used 
in the future ; but the next generation could not pursue the same 
policy, for some one must consume the products of the factories 
built today, otherwise the building of them is wasted effort. 

Alleged Present Consumption of Future Products. — We 
often hear of consumption in advance of production. It is 
said people live on the future. It is frequently argued that 
during the American Civil War we were consuming faster than 
we were producing. It is alleged that the government borrow- 
ings at that time represented the consumption of future earnings. 
But it must be apparent that it is impossible to consume faster 
than we produce unless we consume past savings by not replacing 
worn-out equipment, or by failing to maintain the customary 
stocks of goods, or unless we borrow from other nations. We 
cannot eat today the wheat or potatoes of tomorrow, nor can 
we wear coats before they are made. What is alleged can never 
be true except of the individual consumer within the nation, 
or of the nation as a whole when the capital or other wealth 
of the country is diminishing, or when its foreign debt is in- 
creasing. What really happened at the time of the Civil War 
was this : we as a nation became indebted to some extent 
to foreigners, and within the nation some of us gained while 
the rest were losing. Government borrowings do not represent 
a present consumption of future wealth, but a special present 
use of purchasing power for which a government agrees to re- 
munerate its owners in the future. If war can be carried on 
with the aid of borrowings, it can, — leaving out of considera- 
tion what foreigners send, — with a sufficiently perfect taxing 
machinery, conceivably always and practically sometimes, be 
carried on without borrowing. It is only a question of how to 
get hold of the means of producing powder and bullets and the 



CONSUMPTION 143 

necessaries of life. War was formerly carried on without bond 
issues ; they are a comparatively recent contrivance. Consump- 
tion can never anticipate future production for the nation as a 
whole taken by itself ; it can only anticipate future ownership. 

Luxury. — Luxury is the name of a vague something which 
society has always viewed with a sense of mingled tolerance 
and condemnation. What is its meaning? In the first place, 
it is clear that people ordinarily consider as luxuries many things 
in themselves innocent and desirable, as handsome dresses, 
jewels, pictures, etc. No one but an ascetic will condemn as 
wrong in themselves things that appeal to taste and finer appre- 
ciations, and yet we feel that the use of such things is not always 
justifiable. Second, the popular idea of luxury recognizes a 
difference in persons. We cannot help condemning in one 
person what we approve in another. Third, we judge luxury 
differently at different times. There is a continual transfer 
of articles from the list of luxuries into that of comforts and 
necessities. This transfer is brought about by the consensus 
of social judgment, and is increasingly acquiesced in by all. 
So we see that the term " luxury " does not apply to goods of a 
certain character, but to certain goods in their relation of time 
and person. For the purpose of discussion, we shall define 
luxury simply as excessive personal consumption. 

Our definition of luxury as excessive consumption necessarily 
condemns it as unjustifiable, but this should not be taken as a 
condemnation of an enjoyment of more than the simplest kind of 
life. There would be little purpose in producing wealth in 
larger and larger volume if it did not mean a higher and better 
standard of life. But this meaning does not justify the 
squandering of immense sums on passing caprices whose satis- 
faction cannot be justified from the standpoint of what is a 
sane life. Nor does it constitute a defense of ostentatious ex- 
penditure. Extravagant expenditure is sometimes condoned 
on the ground that it gives employment to labor, but obviously 
just as much employment would be given to labor by an equiv- 
alent expenditure for laudable purposes. Expenditures for 
any present gratification can be made only by reducing the 



144 OUTLINES OF ECONOMICS 

amount either of other expenditures or of savings. Rarely in 
these days are savings hoarded : they are used for gainful, often 
for socially productive, purposes. Extravagant expenditures, 
therefore, may divert productive agencies into employments 
less beneficial to society. Moreover, to look upon expenditure 
as desirable because it gives employment to labor, or " puts 
money in circulation " and " makes trade good," is to forget 
that, ethically viewed, production is justified only through the 
satisfaction of human wants, and so far as the wants satisfied 
are trivial or worse the necessary productive effort is virtually 
wasted. 

Harmful Consumption. — We have been careful to avoid 
the impression that luxury consists in the use of pernicious goods. 
It is a common query, " Why should I not have this if it does 
me no harm? " This we have tried to answer in the preceding 
paragraphs. A luxury may be a positive good in itself, a satis- 
faction which society may weU hope to make general, but it is 
a good which society cannot yet afford, because other and greater 
wants are yet unsatisfied. But there is another kind of con- 
sumption which is objectionable in an entirely different way, 
not because it is excessive or premature, but because it is harmful 
in itself. Aside from the fact that such consumption usually 
tends to diminish the sum total of the durable satisfactions that 
the consumer gets out of life, it ordinarily lowers his productive 
efficiency, and this involves a further loss to himself, to any who 
may be dependent upon him, and to the whole community. 

Statistics of Consumption. — Instructive investigations have 
been made as to the relative importance of the leading items 
in the family budget. The late Ernst Engel, the former dis- 
tinguished head of the Prussian Statistical Bureau, advanced 
the theory that it might be possible by a careful study of a suffi- 
cient number of family budgets for a period of years to indicate 
the broad changes in consumption, and thus by a sort of social 
signal service to predict the coming of industrial storms. Noth- 
ing has been so far accomplished along this line, but Engel's 
tables are important in other ways. From Table I (page 145) 
he deduces the following four propositions : . 



CONSUMPTION 



145 



1. The greater the income, the smaller the relative percen- 
tage of outlay for subsistence. 

2. The percentage of outlay for clothing is approximately 
the same, whatever the income. 

3. The percentage of outlay for lodging or rent, and for fuel 
•and light, is invariably the same, whatever the income. 

4. As the income increases in amount the percentage of out- 
lay for sundries becomes greater. 

TABLE I 

Engel's Statistics — Saxony 



Per Cent of the Expenditure of the 
Family of 



Items of Expenditure 



A Workingman 

with an Income 

of from $225 

to $300 a year 



A Man of the 
Middle Class 
with an Income 
of from $450 
to $600 a year 



A Man in Easy 
Circumstances 

with an Income 
of from $750 

to $1000 a year 



1. Subsistence 

2. Clothing 

3. Lodging 

4. Heat and light .... 

5. Education, pubKc worship, 

etc 

6. Legal protection .... 

7. Care of health 

8. Comfort, mental and bodily 

recreation 

Total 



.62.0 

16.0 

12.0 

S-o 

2.0 

i.o 

I.O 



9S-0 



S-o 



SS-ol 
18.0 
12.0 
S-o J 

3-5 

2.0 
2.0 

2.5 J 



90.0 



50.0 

18.0 

12.0 

S-o 

S-5 
3-0 
3-0 

3-5 J 



85.0 



15.0 



The reader will perceive that if Engel's table, published in 
1857, had been constructed in recent years, somewhat different 
limits would have to be set for " middle class " incomes even 
in Germany. 

Subsequent investigations in the United States have confirmed 
in a general way the conclusions of Engel, but the correspondence 
is not exact, as will be seen from Table II, from the reports of 
the United States Bureau of Labor, summarizing the expendi- 
ture of over two thousand families in 1891 and over eleven 
thousand in 1903. 

L 



146 



OUTLINES OF ECONOMICS 



Table III gives the results of a careful study of the budgets 
of 383 families in New York. 

TABLE II 

Expenditures of American Families Investigated by the United 
States Bureau of Labor 

(From the Seventh [1891] and Eighteenth [1903] Annual Reports) 







Per Cent of Total Expenditure 


Income Group 


Food 


Clothing 


Rent 


Fuel and 
Light 


Miscella- 
neous 




1891 


1903 


1891 


1903 


1891 


1903 


1891 


1903 


1891 


1903 


Under $200 
$200-300 . 
$300-400 . 
$400-500 . 
$500-600 . 
$600-700 . 
$700-800 . 
$800-900 . 
$900-1000 
$1000-1100 
$1100-1200 
$1200 or over 




49.6 
44-3 
45-6 
45-1 
43-8 
41.2 

38.9 
38.1 

34-3 
34-7 
30-7 
28.6 


50-9 

47-3 
48.1 
46.9 
46.2 

43-5 
41.4 
41.4 

39-9 
38.8 

37-7 
36.5 


12.8 

14-3 
14.1 
14.4 
15-3 
15-9 
16.3 

iS-i 
16.8 

17-5 
16.5 
iS-7 


8.7 
8.7 

lO.O 

11.4 
12.0 
12.9 
I3-S 
13-6 
14.4 

iS-i 
14.9 

iS-7 


15-5 

14.7 
15.0 

iS-3 
15.2 

iS-S 
15-6 
16. 1 
14.9 

iS-i 
12.2 
12.6 


16.9 

18.0 

18.7 

18.6 
18.4 

I8.S 

18. 1 
17. 1 

17.6 

17-5 
16.6 
17.4 


8.1 
7.6 
7.0 
6.6 
6.6 
S-9 
5-3 
5-3 
4-7 
4-5 
3-9 
3-0 


8.0 
7.2 

7-1 
6.7 
6.2 
5-8 
5-3 
5-0 
S-o 
4.9 

4-7 
5-0 


14.0 
19.2 
18.3 
18:6 
19.I 
21.6 

23-9 
25-S 
29.1 
28.1 

36.7 
40.1 


•iS-6 
18.8 
16.1 
16.S 
17.2 
19.4 
21.6 
23.0 
23.2 

23-7 
26.1 

25-4 


All . . 




41.4 


43-1 


iS-3 


13.0 


iS-i 


18.1 


5-9 


5-7 


22.7 


20.1 



Consumption and Sacrifice. — Over against the enjoyment 
resulting from wealth consumption lies the discomfort of wealth 

production. Enjoyment, we 
have seen, grows less and less 
as the consumption of a partic- 
ular good is continued, but the 
irksomeness of producing it, on 
the contrary, grows greater and 
greater the longer labor is con- 
tinued. Let us take the case of 
Robinson Crusoe picking berries. We may represent the 
diminishing utility of the berries to him by the line ab (Fig. i) , 
and the increasing irksomeness of picking them by the line cd. 




Fig. 



CONSUMPTION 



147 



TABLE III 

Expenditures of Families in New York City : 1907 ^ 







is 


Expenditures 


Income 
Group 


Food 


Cloth- 
ing 


Rent 


Fuel 
and 
Light 


Insur- 
ance 


Health 


Carfare 


Sun- 
dries 
























Per cent 


Per cent 


Per cent 


Percent 


Per cent 


Per cent 


Per cent 


Per cent 


$400-499 


8 


40.8 


13.0 


26.8 


5-6 


1.2 


3-1 


2.6 


6.9 


$500-599 


17 


44.4 


12.4 


25-9 


5-9 


1-3 


1.9 


1.8 


6.4 


$600-699 


72 


44-6 


12.9 


23.6 


S-« 


2.0 


2.1 


1-7 


7-3 


$700-799 


79 


45-6 


13-4 


21.9 


5-0 


2-5 


1.9 


1-5 


8.2 


$800-899 


73 


44-3 


14.0 


20.7 


5-0 


2.2 


2.7 


2.0 


9.1 


$900-999 


63 


44-7 


14.6 


19.0 


S-i 


2.6 


2.6 


1-5 


9.9 


$1000-1099 


31 


44-7 


I5-S 


18.1 


4-S 


2-5 


i-S 


1.8 


11.4 


$1100-1199 


18 


45-6 


14.9 


16.2 


3-« 


2-5 


3-6 


1.9 


"•5 


$1200-1299 


8 


45 -o 


15.2 


19.8 


3-H 


2.2 


1-3 


2.2 


10.5 


$1300-1399 


8 


43-6 


13-7 


16.8 


3-6 


4.9 


I.I 


I.I 


15.2 


$1500-1599 


6 


36.8 


16.8 


16.3 


4.1 


2-3 


7-4 


1.2 


15-1 



He would not pick more than Ox, because the xth berry costs him 
just as much pain as it yields him pleasure, and any further 
continuance of gathering fruit would result in an excess of 
pain. The degree of utility represented by mx, then, repre- 
sents, at the moment that the rrth berry is picked and eaten, both 
the marginal utility and the marginal disutility, or marginal 
pain or sacrifice. 

Each of us has sometimes made such comparisons — bal- 
ancing the pleasure of further consumption against the pain of 
further production. Many persons who are working eight or 
ten hours a day could increase their income somewhat by work- 
ing twelve hours, but the • additional discomfort is greater in 
their estimation than the additional fruits of their labor would 
be worth. To be sure, much of our economic action goes on 
unconsciously. We accept a position, comparing its advantages 
and its disadvantages in a general way with those of other 
openings, but once we enter upon the work, we accept the 
daily grind as inevitable, and, in spending our income, think 

' R. C. Chapin, The Standard of Living in New York City, p. 70. 



148 OUTLINES OF ECONOMICS 

not of the sacrifices it has cost us, but simply of how we can 
get the maximum satisfaction from it. 

In discussing future wants we saw that postponing the con- 
sumption of goods from the present to the future came to re- 
quire compensation only after a certain amount had been saved. 
Under present methods of production, it was explained in the 
preceding chapter, a large amount of this postponement of 
consumption is required. Machines must be made, and the 
result of this labor cannot be enjoyed until these machines have 
been used up in making finished products. This means that 
some one must wait for the result, and in^many cases be paid 
to do it. Thus production may require, in addition to com- 
pensation for labor, a payment for waiting. This is a point 
which will be discussed further in the chapter on interest. 

Cost of Production, Expense of Production, and OT»portunity 
Cost. — The preceding paragraphs explain one important 
sense in which the term " cost of produfction " is used, i.e. (i) 
the subjective cost of irksome labor or reluctant waiting. But (2) 
the phrase is also commonly used to refer to the expense oj 
production, that is, the amount of money spent in producing a 
commodity. (3) A third meaning is also found, which has been 
termed opportunity cost. Let us say that a person is confronted 
by the alternative of engaging in either of two occupations. 
He may become a lawyer or he may become a merchant, but 
he has not the time to be both. If he chooses to be a lawyer, 
he sacrifices his opportunity of being a merchant. Cost in 
this sense is sometimes called " alternative cost," or " displace- 
ment cost." This is not an ultimate cost, but it probably has 
a more direct and more important influence upon most of our 
economic choices and decisions than has any other kind of cost. 
Moreover, in the actual conduct of life opportunity cost and 
direct cost are generally inextricably blended. The increasing 
irksomeness of Crusoe's task of picking berries, for example, 
may be deemed to have been caused in large measure by the 
pressure of other demands upon his time. We haven't time 
enough to do all the things we should like to do, and so we have 
to apportion our time according as we think that one use of 



CONSUMPTION 149 

it or another is the more important. And, in general, we try 
so to apportion our time that the fruits of the last or marginal 
increment of time devoted to any one purpose shall have no 
more or no less utility than those of the marginal unit of time 
devoted to any other purpose. 

Taking " leisure " as a collective name for all of the non- 
economic uses of time, that is, for all uses of time for other than 
productive or money-making purposes, it appears clearly that 
a worker with free command of his time will carry his chosen 
line of effort up to the point (or margin) where leisure attracts 
him as much as the products of his exertion, or, in modern 
economic life, as the* things he can acquire with the money he 
earns. As in the expenditure of money, so in the expenditure 
of time and effort : we tend to bring our expenditures up to 
margins wtere utilities gained and utilities sacrificed or foregone 
are equal. 

QUESTIONS AND EXERCISES 

1. If you had four sacks of corn all alike, could you tell which is the 
marginal one? 

2. May one properly speak of the marginal utihty of an indivisible good,^ 
a house, for example? 

g. If an individual estimates his present wants as 10, 8, 6, 3, i, and his 
future wants as equivalent to the present value of 9, 7, 5, 2, o, and if he has 
$9, and if each want is satisfied with $1, how many dollars will he save? 

4. Give as many expressions as possible that are equivalent to the term 
"subjective value." 

5. Comment on the following: "Doubtless the best thing to do about^ 
them (the spendthrifts) is to do nothing — not even to worry about their 
waste of money. Their waste of money, in fact, is the least silly thing they 
do, for the money is in constant flux and serves its purpose." World's 
Work, June, 1906. 

6. Comment on the following words of Adam Smith : "Nothing is more 
useful than water; but it will purchase scarce anything; scarce anything 
can be had in exchange for it. A diamond, on the contrary, has scarce any 
value in use, but a very great quantity of goods may frequently be had in 
exchange for it." Wealth of Nations, Book I, Chap. iv. 

7. Point out the differences in the tables of consumption statistics quoted 
in the text. How do they modify Engel's statements ? Suggest explanations 
of these differences. 



ISO OUTLINES OF ECONOMICS 

REFERENCES 

Bohm-Bawerk, E. von. Positive Theory of Capital, Book iii, Chaps, iii 

and iv. 
Chapin, R. C. The Standard of Living in New York City. 
Davenport, H. J. Economics of Enterprise, Chaps, vii, viii. 
HOBSON, J. A. The Social Problem, Book ii, Chap. vii. 
Jevons, H. S. Essays in Economics, Chaps, ii, iii. 
Marshall, Alfred. Principles of Economics, 6th ed., Book iii. 
Mayo-Smith, Richmond. Statistics and Economics, Book i. Chap. ii. 
More, L. B. Wage-Earners' Budgets. 
Rowntree, B. S. Poverty, Chaps, vi-viii. 
Streighthoff, F. H. The Standard of Living among the Industrial People 

of America, Chap. ii. 
Urwick, E. J. Luxury and Waste of Life, Chap. iii. 
Veblen, Thorstein. The Theory of the Leisure Class. 
Watkins, G. p. Welfare as an Economic Quantity, Chaps, i, iv. 
WiCKSTEED, P. H. The Common Sense of Political Economy, Book i, Chaps. 

i, iii. 
Withers, H. Poverty and Waste, Chap. viii. 



PART II 
VALUE AND EXCHANGE 

CHAPTER X 
VALUE AND PRICE 

If every family produced all the goods needed to supply the 
wants of its members, most of the problems which today con- 
front economic science would not exist. Most of the world's 
workers are, however, contributing their services either directly 
or indirectly (through the production of goods) toward the 
satisfaction of the wants of others. One's economic well- 
being today depends primarily on two things : the money in- 
come which can be got from others in return for one's services 
or for the use of one's land or capital, and the amount of things 
that can be bought with this money income. The federal census 
of 1 910 showed that about 93 per cent of the men over twenty 
years old and about 18 per cent of the women of corresponding 
age were employed in money-making occupations ; and this 
number does not include those landlords and capitalists whose 
income was derived entirely from their investments. The work 
of the housewife and the services of friendship embody utilities, 
that is, satisfy human wants, just as do money-making activities, 
but they are not reported in terms of dollars and cents. The 
production of wealth is in these days mostly " for the market," 
and wants are satisfied very largely by goods obtained from the 
market. In the vast interlocking system of modern economic 
life most goods get from those who produce them to those who 
use them by the processes of exchange. 

The Meaning and Significance of Value. — It rarely happens 
nowadays that goods are directly exchanged for other goods. 

151 



152 OUTLINES OF ECONOMICS 

Goods are usually sold for money/ and the seller uses the money 
in the purchase of other goods. The amount of money for which 
a unit of a given commodity exchanges is the price of that commodity. 
Since prices vary, when we wish to name the actual price of 
any commodity we must specify the price in a given market at a 
given time. 

From this simple and familiar concept of price there has been 
developed the more general concept of exchange value. If a 
hat sells for two dollars, a pair of shoes for four dollars, and a 
pocket knife for fifty cents, we say that the exchange value of 
the hat is half that of the pair of shoes and four times that of the 
knife. It thus comes about that we attribute exchange values 
to goods in accordance with their relative potency in exchange, 
as shown by the prices at which they sell. In this way values 
come to be thought of as magnitudes. Just as weight and 
volume are physical magnitudes by which we express the rela- 
tive heaviness and the relative bulk of different objects, so ex- 
change values are economic magnitudes or, more specifically, 
exchange magnitudes. The exchange value of a good is thus 
the resultant of its exchange relations with other goods. 

Exchange value is a purely relative or comparative magnitude, 
and there is no way of expressing or measuring the exchange 
value of a good except in terms of its command over other goods. 
In such a measurement exchange value can be expressed either as 
a quantity or as a ratio. We can say (i) that the value of a pair 
of shoes is that of eight knives or (2) that the value of the shoes 
is to the value of a knife as eight is to one. We thus express the 
exchange value of any good either by stating the quantity of 
other goods that can be obtained for it or by stating its ratio 
of exchange with other goods. The exchange value of any one 
commodity can, of course, be expressed in terms of any other 
commodity. Price is a statement or expression of exchange 
value in terms of money. To say that the price of a pair of 
shoes is four dollars amounts to saying that the value of the pair 
of shoes is four times the value of a dollar. When the words 

1 In this chapter the word " money " is used in its broadest sense, thus including 
credit instruments, which are, of course, merely promises to pay money. 



VALUE AND PRICE 1 53 

" value " and " price " are used interchangeably, as will some- 
times be our practice in this book, there is implied the assump- 
tion that the value of money as expressed in terms of other things 
than the particular commodity we are discussing is constant, — 
an assumption which, of course, does not entirely correspond 
with the facts. 

Exchange values are determined by what may be called 
the "price process." This term is used in a narrow sense as 
referring to the fixing of the money values of commodities ; 
in a broader sense it includes also the determination of the 
different rewards received by those who have contributed to the 
production of these commodities. In this broad sense the prob- 
lem of prices is the problem of the distribution of wealth. 
Imagine the case of a mechanic employed at a particular time in 
the manufacture of machinery that will be used in a flour mill. 
The final product of the mechanic's labor — the only product 
directly useful in the satisfaction of human wants — is the flour, 
or bread made from the flour. To the making of this final prod- 
uct thousands besides our mechanic — farmers, agricultural la- 
borers, railway officers and employees, other mechanics, and so 
on in a practically endless list — have contributed. What deter- 
mines the price of the final product? What proportion of this 
price goes to the mechanic ? What is his share worth to him as 
the means of getting the necessaries of life? Of these three ques- 
tions, the first and third fall within the problem of the prices 
of commodities ; the second, relating to the wage-price of the 
mechanic's services, falls within the problem of the distribution 
of wealth. At present we are concerned only with prices in their 
narrower sense, although the principles to be developed apply 
also in the case of the prices paid for the services of the factors in 
production. The significance of the subject of value in economic 
science lies in the fact that, within the conditions set by existing 
institutions, and within the limits set by the total production of 
wealth, human welfare, so far as it is dependent upon the pos- 
session of economic goods, is largely determined by the process 
of fixing price relations. 

The Market. — It is conceivable that the prices of goods 



154 OUTLINES OF ECONOMICS 

might be fixed by public authority, or that the production of 
the most important commodities might be monopohzed. Then, 
too, it is possible to imagine a condition of society in which 
custom should have such power that prices, when once estab- 
lished, would be changed very infrequently. Still another 
possibility is a regime of competition in which every man is 
left free to buy and sell as he pleased at such prices as he can 
get. The first three factors — public authority, monopoly, 
and custom — are among the things which determine the ratios 
at which goods are actually exchanged today ; but the dominant 
factor is the fourth one mentioned — the free competition of 
the market. 

In this connection we mean by the market, not a particular 
place for buying and selling, but the general field within which the 
forces determining the price of a particular commodity operate. For 
some commodities, especially perishable ones, like fresh milk and 
cream, the market is distinctly a local one. In the case of great 
staple commodities like wheat and cotton, the market is a world 
market, for it is impossible that the prices of wheat or cotton in 
Europe should differ for any considerable time from their prices 
in America by more than the expense of transport. So-called 
" international " securities, such as government bonds and the 
stocks and bonds of certain great corporations, afford even a 
better example of goods for which the market is a world market. 
Some commodities are used only in a particular locality or 
country, although produced in many different places. The 
American consular reports frequently contain advice to Ameri- 
can manufacturers as to special kinds and varieties of goods used 
in different foreign countries. The cotton mills of England, 
Germany, and the United States all make special grades of 
cotton cloth designed especially for the Oriental market. Much 
more numerous, however, are the goods which, although of 
wide and general consumption, are produced in but few localities. 
This is especially evident in the case of agricultural and mineral 
products, but it is increasingly noticeable in manufactures. 

Along with this localization of industry there has been a 
broadening of the field of consumption of many commodities. 



VALUE AND PRICE 155 

Among the factors which have contributed to this result may be 
mentioned, first, the increasingly cosmopolitan character of 
modern life, — a result of more generally diffused facilities for 
higher education, as well as of the growing ease of travel and 
communication ; and secondly, what has been called the 
" standardization of taste," — a result in part of modern ad- 
vertising methods and of the standardization of products 
which is one of the fundamental features of modern machine 
industry. Notwithstanding the barriers which still exist in 
the form of protective tariffs and local prejudices, a dominant 
feature of modern markets is the increasing localization of 
production and the extension of the field of consumption. 

Exchange Value and Subjective Value. — Exchange value is 
often called market value or objective value, and is sharply to be 
distinguished from subjective value, which, it will be remem- 
bered, is the relative importance attached by an individual to 
a particular unit of a commodity. Exchange value is an objec- 
tive, ascertainable fact of the market. Subjective value is a 
matter of individual feelings and preferences, and is different 
for different individuals. An error which we must especially 
guard against is that of thinking that exchange values are in 
any accurate sense the expression of the subjective values of 
different goods to society at large. Exchange value is the out- 
come, the resultant, of the individual subjective valuations of 
many different persons, the poor and the rich, the wise and the 
foolish, but it does not correspond to '' social subjective value," 
or " social marginal utility," for these two last phrases are 
meaningless. It is true, of course, that our own valuations 
are largely socially determined in the sense that, lacking much 
real independence of judgment, we follow and imitate other 
people in making our own estimates of the relative desirability 
of different commodities, and that we are even prone to judge 
of the relative importance of different things for our own pur- 
poses by their costliness, that is, by their exchange values, 
rather than by an independent analysis of our own needs. But 
the differences in our tastes and the differences in our powers 
to gratify our tastes are quite as important factors in determining 



156 OUTLINES OF ECONOMICS 

the exchange values of things as are our similarities. Just 
what is the point of connection between subjective values and 
exchange values we shall discover in the analysis of supply 
and demand. 

Supply and Demand. — The only goods which are valued in 
the market are economic goods ; that is, such goods as combine 
the characteristics of utility and scarcity. This statement is 
a truism, for no one will pay for things that he does not want or 
for things that can be obtained freely. Utility and scarcity 
affect the market value of goods through the operation of the 
forces of demand and supply. The general " common-sense " 
explanation of the valuation of goods takes the form of the 
statement that values are determined by supply and demand. 
When rightly interpreted, this statement cannot be criticized, 
but it is often used in a misleading way. Producers do not 
usually throw a " supply " of goods unreservedly on the market, 
accepting any price that can be got for them, nor do consumers 
generally demand definite amounts of goods, without reference 
to the price of them. An entirely accurate statement, and one 
that is less apt to be misinterpreted, is that prices are among the 
factors determining supply and demand. It may seem, accord- 
ingly, something like arguing in a circle to attempt to explain 
exchange value by using the formula of supply and demand; 
but the fact is that the explanation is to be sought in the action 
of mutually dependent forces, rather than in any one principle. 

The Nature of Demand. — Mere desire for a commodity is 
not demand for it. The desire of the poor man for the counter- 
part of his wealthy neighbor's motor car is in no sense demand. 
Effective demand is sometimes defined as desire coupled with the 
abihty to pay. But to make demand really effective there 
must be added to these the inclination to buy : desire must be 
intense enough to lead to purchase. 

If I purchase a certain quantity of a particular commodity, it 
is because I desire it at least as intensely as anything else I can 
purchase with the same amount of money. When I ask myself 
whether a certain contemplated purchase is " worth its price " to 
me, I am comparing the importance of the purchase in question 



VALUE AND PRICE 157 

with the importance of other uses of the money which the 
price represents. It is, in other words, a matter of my subjec- 
tive valuations. Now my subjective valuations, it will be 
remembered, depend not only upon my tastes and my purposes, 
but also (on account of the law of diminishing utility) upon the 
extent to which I am already supplied with goods like that 
whose purchase I am considering, as compared with the extent 
to which I am supplied with other things. In choosing and 
picking among the different alternatives open to me as a pur- 
chaser, in buying one thing rather than another, in acquiring 
more of this and less of that, I merely express my subjective 
valuations. A certain minimum supply of one commodity — 
a necessity of life, perhaps — may be more important to me, 
may possess a higher utility, than any possible amount of some 
other commodity, — a luxury, for example. But I may deem 
it less important to have a large supply of the first commodity 
than to have some of. the second commodity. If I push my 
expenditures for any one purpose too far, I sacrifice the satis- 
faction of more important wants for the, satisfaction of less 
important wants. Think of one's purchases as being divided, 
not into such units as pounds, bushels, yards, and dozens, but 
into units defined by the quantity one can purchase for a dollar, 
— into "dollar's worths." Each of us, by buying the things 
he wants more than he wants other things, tends to keep the 
subjective values of the last or marginal dollar's worths of all 
the different kinds of goods he consumes equal, one to another. 
As our tastes and desires and purposes change we alter our 
scheme of expenditures accordingly, but always so that our 
marginal dollar's worths are kept, as it were, in equilibrium. 
But even if our desires were constant, changes in prices would in 
themselves effect continual alterations in the proportions of 
various things that make up our purchases. The various dollar's 
worths become larger or smaller and acquire larger or smaller 
subjective values. If the price of a commodity decreases to 
such an extent that an additional dollar's worth gains a subjec- 
tive value greater than that of other dollar's worths, we normally 
purchase it. If the price rises, we normally curtail our ex- 



158 



OUTLINES OF ECONOMICS 



penditures for this particular commodity, and may even, under 
some circumstances, become sellers of it (as in the case of the 
householder who has bought a large supply of coal at five dollars 
per ton, and who, when the price rises to ten dollars, is willing to 
sell part of it). Some of the foregoing discussion may seem to 
be a statement of what is obvious and commonplace, but the 
neglect of these seemingly obvious factors is responsible for 
more than one erroneous explanation of the way in which prices 
are determined. 

The Demand Curve. — The relations between price and de- 
mand may be shown concretely by the analysis of the condi- 
tions in a hypothetical market. Imagine the case of an isolated 

community in which wood 
is used as a fuel. The 
conditions might be such 
as are represented graphi- 
cally in Figure i. In this 
diagram distances meas- 
ured from along the 
horizontal line OX rep- 
resent different amounts 
of wood, while distances 
measured vertically from the line OX represent prices. Assum- 
ing that the conditions of demand were as represented in the 
diagram, if the price of wood were MP dollars a cord, OM cords 
of wood would be bought. If MP represents a relatively high 
price for wood, this might mean that many families would 
choose to go without wood, using other kinds of fuel instead. 
Others would be content with a scanty supply. If, however, 
the price were reduced to M' P' dollars per cord, some of the 
families who would have refused to buy at the higher price would 
purchase wood, while others would increase their purchases, so 
that OM' cords would be bought. Similarly, at the price 
M"P", the amount bought would be OM" cords. Other pos- 
sible prices might be indicated on the diagram, so that, in 
general, the curve DD' (which we may call the demand curve) 
represents the relation between price and the amount purchased. 



^ 


p 


J"' 






\ 


p'' 











M 31 ■ 



M" 
Fig. 



X 



VALUE AND PRICE 



159 



x^ 


p 






P' 






~~~— i)' 



M 



.¥' 



X 



Fig. 2. 



More definitely, the demand curve represents the amount of a 
given commodity which can be sold in a given market at each 
of all possible 
prices. 

The Elasticity 
of Demand. — 
By the elasticity X* 
of demand we 
mean the extent 
to which the 
amounts pur- 
chased vary 
with changes in 
price. In every 
family in poor 

or moderate circumstances the housewife carefully economizes 
in the use of eggs during periods when they are high in price, 
using them more freely when the price is lower. The demand for 
eggs is therefore elastic. Relatively inelastic are the demands 

of most families for such 
things as flour and salt. 
Other commodities, such as 
sugar, may occupy an inter- 
mediate position. Figures 
2 and 3 represent, respec- 
tively, elastic and inelastic 
conditions of demand. It 
§Jiould be understood that 
the demand curves for most 
commodities are probably 
not so smooth and regular 
in their slope as are these 
diagrams. It may often 
happen that the elasticity 
of demand is different for different portions of the demand 
curve. The demand for bread, for example, would probably 
be much more elastic at very high prices than at very low 




l6o OUTLINES OF ECONOMICS 

prices. The demand for salt, on the contrary, would prob- 
ably be less elastic at prices so high that it would be used only 
as a food than at prices low enough to permit its use (as at pres- 
ent) for various industrial purposes. Without giving further 
concrete examples, the following propositions respecting elas- 
ticity of demand may be stated : (i) Demand for necessities 
is in general less elastic than demand for luxuries. (2) Demand 
the commodities the use of which constitutes a habit is less 
elastic than demand for commodities the use of which is gen- 
erally a matter of conscious decision. (3) The more adequate 
the substitutes for a particular commodity, the more elastic 
will be the demand for it. (4) The demand of persons of large 
income is less elastic than that of persons in poor or moderate 
circumstances. (5) A corollary of proposition four is that the 
higher the general level of well-being in a community, the less 
elastic will be the demand for most commodities. 

The rectangle OMPA (in any one of the three diagrams) 
represents the total amount buyers pay for a certain commodity 
when the price is MP, just as the rectangle OM'P'A' represents 
the total amount paid when the price is M' P' . If the demand 
for the commodity is distinctly inelastic, this total value will be 
less when the price is low than when the price is high.^ At 
the lower price less money will be expended for this particular 
commodity and more money will be available for other uses. If, 
on the other hand, the relations between price and demand are 
such that the rectangle OM'P'A' is larger than the rectangle 
OMPA, a drop in price from MP to M' P' will result in a 
curtailing of expenditures for other things. This might involve 
only a decreased use of direct substitutes, such as coal in place 
of wood ; generally, however, it would mean a diminished con- 
sumption of a number of other things. But this is a gain, not 

1 Elasticity of demand may be represented mathematically by a fraction whose 
denominator is the relative (or percentage) decrease in price and whose numerator 
is the corresponding relative increase in the amount demanded. Following the nota- 
tion used in Figures 2 and 3, this is the ratio of MM'/OM to AA'/AO. When the 
elasticity of demand, thus expressed, is equal to MM'/OM -j- i, the rectangles 
OMPA and OM'P'A' are equal; that is, the same total amount is expended for 
the commodity when the price is MP as when the price is M'P'. 



VALUE AND PRICE l6l 

a loss. For the lower price would not be accompanied by the 
purchase of a larger quantity, if the additional purchases did 
not satisfy more intense wants than other things that might 
have been purchased with the money. Larger " dollar's 
worths " will have been substituted for smaller ones. 

In this way the demand for any one commodity is affected 
by changes in the prices of other commodities. The competition 
of the market thus embraces not only the buying and selling 
of one commodity, but also the buying and selling of all com- 
modities. In this sense the wood dealers compete with the 
grocers and the tailors, as well as with the coal dealers and with 
each other. 

Consumers^ Surplus. — Whatever the price of a competitively produced 
commodity may be, there are almost always some buyers who would have 
paid more if it had been necessary. Referring to Figure i,. if the price is 
M'P', those who are just willing to pay that price, who would either have 
bought less or bought none if the price had been higher, may be called the 
marginal buyers. These are relatively few in number, however, as compared 
with those who would have bought even if the price had been higher. The 
utility of the marginal purchases to the buyers is but little more than the 
utility of other things that could have been bought with the same amount of 
money : in such cases the utility of the purchase only about equals the sacri- 
fice involved. In the case of all other purchases, however, there is a surplus 
of utility over costs (whether costs are measured as money costs or as the 
utility of the other possible purchases which are given up) which is called 
consumers' surplus (or sometimes consumers' rent, or buyers' gains). 

It might be supposed at first thought that if the price were, for example, 
M'P' (Fig. i), the area included between the horizontal line A'P' and the 
curve DP^ would represent consumers' surplus. This is not exactly true, 
however, and that for two reasons : in the first place, the satisfaction of 
additional wants which a lower price makes possible may make the more 
important wants less intense. A man might be willing to give ten dollars 
for a cord of wood in order that at least one room in his house could be heated 
during the winter. He might also be willing to give seven dollars a cord for 
two cords, so as to heat two rooms, but the heating of the second room might 
render the heating of the first room less important to him. He might not 
be \villing, for example, to give ten dollars plus seven dollars in order to 
have the two rooms heated. In the second place, utility itself is to a large 
extent affected by price. So far as our purchases satisfy what has been 
called the desire for distinction, or represent what Professor Thorstein 
Veblen has called "conspicuous consumption," a lowering of the price of a 

M 



l62 OUTLINES OF ECONOMICS 

commodity would lessen its utility to us. The successful production of 
artificial diamonds at a low cost would lessen the desire which most people 
have for natural ones. If touring cars were less an indication of one's 
ability to spend money freely, they would be less esteemed by not a few 
people. On the other hand, it might occur in some cases that a certain 
amount of decrease in the price of a commodity, permitting a more general 
consumption of it, would increase the esteem in which it is held by those 
who are glad to follow fads. In general, we must say that even if we had 
absolutely complete statistics of the actual relation of prices to demand, 
consumers' surplus would still be an incommensurable thing. It is neverthe- 
less a real thing, and is especially significant as constituting one of the differ- 
ences between real income and money incomes. 

It should be noted, however, that consumers' surplus relates only to one's 
consumption of a particular commodity, taken by itself, for, as we have seen, 
the amount which we are willing to spend in the purchase of any one com- 
modity depends not only on the price of that commodity, but also on the 
prices of the other commodities that make up our purchases. The suipluses 
which a consumer gets in his different lines of consumption cannot be 
added together to form a total. I might, for example, be wiUiiig to pay 
as much as four dollars for a hat that I can get for two dollars. And if I 
pay only two dollars for the hat I might be willing to pay as much as six 
doUars for a pair of shoes that I can get for four doUars. But it does not 
follow that I should be willing to pay four doUars for the hat and six dollars 
for the shoes. 

The Nature of Supply. — The amount of goods that will be 
supplied in a given market at a given time depends, like the 
amount demanded, on the price. " Forced sales," in which 
goods are offered for whatever can be got for them, form about 
the only important exception. The effect of price on supply 
varies, however, according to the length of time that is taken 
into consideration. The work that is being done today in the 
extension of old factories and the building of new ones, the con- 
struction of railways, the taking up of new land, is based on 
estimates of future prices, the present prices of agricultural and 
manufactured products and of railway transportation being of 
significance only so far as they indicate what future prices will 
be. The merchant's stock in trade is bought on an estimate of 
future business conditions; the amount of land the farmer 
allots to wheat and corn, respectively, depends on his estimate 
of the relative prices the two will bring after the harvest. In a 



VALUE AND PRICE 



163 



similar way the amounts of goods that can be supplied to the 
market today are limited by the estimates which business men 
and farmers have made in the past of the prices which buyers 
are willing to pay today. It would be possible, though not 
necessary for our purposes, to analyze, the way in which the 
amount of the capital and labor which have thus been applied 
to the production of things that will satisfy present wants was 
partially determined by conditions which existed still farther 
back in the past, and so on in an indefinitely receding series. 

The amount of goods available for the market of today is 
thus determined not only by past estimates and conditions, but 
also by present estimates of future conditions. Every seller has 
the option of selling at the present price or of waiting for possibly 
higher future prices — an option which is limited only by the 
perishability of his goods and the urgency of his need for money. 
And the most urgent need for money does not necessarily force 
an immediate sale if his opinion as to the future value of his 
goods is a reasonable one, for in this case it is usually easy to 
borrow money on the strength of the marketable value of the 
goods. 

The Supply Curve. — In the analysis of the conditions of 
supply existing in a particular market at a particular time we 
do not have to take account of 
the limitations imposed by the 
forms which productive efforts 
have taken in the past. At 
any given time a certain defi- 
nite amount of a commodity is 
available for the market : this 
forms what may be called the 
potential supply. The propor- 
tion of this potential supply 
that sellers will be willing to 
part with at a particular time will depend primarily on the prices 
they can get. If the price of a unit of a commodity is M' P' 
(Fig. 4), the sellers will be willing to sell a certain number of 
units of it, which may be represented by OM' . If the price were 




164 



OUTLINES OF ECONOMICS 



as low as PM, however, some sellers would prefer to wait for 
higher prices, the amount thus withheld from the market being 
represented by MM'. At the price M"P", however, an addi- 
tional supply {M'M") of the commodity would be forthcoming 
from sellers who were not tempted by the price M'P'. In gen- 
eral, the supply curve SS' represents the relations between price 
and the amount that will be supplied in a particular market 
and at a particular time. 

The Determination of Price. — The foregoing discussion of 
the nature of demand and of supply makes it possible to ad- 
vance another step in 
our analysis of the de- 
termination of price, by 
asking ourselves what 
will be the result of the 
simultaneous operation 
of the forces of demand 
and supply. This con- 
dition is represented 
graphically in Figure 5, 
where the demand curve 
and supply curve are 
combined in one diagram. If the curve DD' represents the 
potential demand in a particular market at a particular time, 
and the curve SS' represents the potential supply, the price 
which would be fixed by the free working of competitive forces 
would be PM, located at the point where the two curves cross. 
At this point demand and supply are equal, both being rep- 
resented by OM. It is impossible that the price should be 
fixed at any other point, M'P', for example. For if M"Q be 
drawn so as to equal M'P', it will be evident that at this price 
OM" units will be demanded, while only OM' units will be sup- 
plied. Most of the buyers, however, are willing to pay more 
than M'P' if necessary, so that in order to secure their share 
they will bid the price up until an equilibrium is reached. 
This is what John Stuart Mill meant when he said that " value 
always adjusts itself in such a manner that the demand is equal 




VALUE AND PRICE 1 65 

to the supply," — a statement which has often been misinter- 
preted, and consequently unjustifiably criticized. 

The prices for which goods are sold in a competitive market 
are thus the outcome or resultant of the individual valuations of 
all who buy and sell in the market. Each buyer or seller, 
taken by himself, affects only inappreciably the price at which 
he buys or sells. All that he can do is to buy or sell or refuse 
to buy or sell, or to buy or sell more or less. For each individual 
trader the market price is something beyond his own control. 
And yet each has a part in that collective supply and demand 
which is the controlling factor in making the price whatever it 
happens to be. 

Producers' Surplus. — Just as the area APD (Fig. 5) has sometimes been 
considered, not altogether accurately, to represent a "Consumers' Surplus" 
(of utility over costs), so the area APS has been considered to correspond to 
what has been called "Producers' Surplus" or "Sellers' Gains." This sur- 
plus should not be thought of as corresponding to the actual profits of the 
sellers ; that is, as being in any way a surplus of receipts over and above the 
expenses of production. That part of the supply which had been produced 
at the smallest expense is not necessarily the part which its owners would 
be willing to sell at the lowest price. It cannot be too strongly emphasized 
that the analysis of demand and supply thus far presented relates only to 
the conditions existing in a particular market at a particular time. All that 
we can say is that when OM units are sold at the price of MP per unit, the 
total receipts of the sellers are represented by the rectangle OMPA ; while 
the area OMPS represents what they would have been willing to sell the 
same amount of goods for, had they not been able to get a larger return. 
There is, as we shall see, a relation between the prices of things and the ex- 
pense of producing them, when a considerable period of time is taken into 
consideration. At any given time, however, sellers are mainly governed 
by the relative profitableness of selling at existing prices or waiting for 
higher ones. The only kind of surplus which the area APS represents is 
an intangible, hypothetical thing, — the difference between actual receipts 
and the amount which would have been received if each seller had sold each 
portion of his supply for the minimum price he would have been willing to 
take for that portion. 

QUESTIONS 

1. Is there such a thing as "intrinsic value"? What is usually meant 
when the expression is used? 

2. How can one buy more or less of a non-divisible good, like a house? 



1 66 OUTLINES OF ECONOMICS 

3. Does the tendency of each individual to maintain the equilibrium of 
his margin of consumption result in the maximum satisfaction of his wants ? 

4. What relation is there between the amounts which a college student 
pays for room rent, for food, for clothing, for books, and for athletics ? 

5. Which of your customary purchases would you still make if prices 
were doubled? Which would you curtail? Which would you omit? 

6. Illustrate the propositions relating to elasticity of demand (p. 160) by 
concrete examples. 

7. Construct an imaginary demand "schedule," showing in parallel 
columns (i) six or eight different possible prices of wood per cord, and (2) 
the number of cords which an imaginary purchaser would buy at each stated 
price. Construct in the same way other demand schedules for each of four 
other possible purchasers. Combine these five individual demand schedules 
into a collective demand schedule showing the total amount of wood that 
could be sold at each price. Construct in a similar way individual supply 
schedules and a collective supply schedule for four sellers of wood. Assum- 
ing that all the wood sold is sold at a uniform price, how much wood will 
be sold and at what price ? 

8. "For some years the supply of Brazilian coffee was greater than 
the demand for it." Criticize and amend this statement. 

REFERENCES 

Bohm-Bawerk, E. von. Positive Theory of Capital, Book iv. Chaps, i-vi. 

Carver, T. N. Distribution of Wealth, Chap. i. 

CuNYGHAME, Henry. Geometrical Political Economy, Chaps, iii and iv. 

Davenport, H. J. Economics of Enterprise, Chaps, v-vii. 

Fetter, F. A. Economic Principles, Part i. 

Marshall, Alfred. Principles of Economics, 6th ed.. Book iii and Book 

V, Chaps, i and ii. 
Mill, J. S. Principles of Political Economy, Book iii. Chaps i and ii. 
Taussig, F. W. Principles of Economics, Vol. i. Chaps viii-x. 
Wieser, F. von. Natural Value, Book ii, Chaps i-v. 



CHAPTER XI 
VALUE AND PRICE (Continued) 

Some of the most important factors in the determination of 
exchange values are not revealed by an analysis of the conditions 
of supply and demand which happen to exist at a particular 
time. In the preceding chapter we assumed the existence 
of a certain potential demand and a certain potential supply^ 
and explained how these result in the equilibrium of actual de- 
mand and supply at a certain price. Our next task is to 
inquire into the influences which determine potential demand 
and potential supply. For this purpose we shall need to pass 
from the study of the way in which the preferences and choices 
of individual buyers and sellers react upon and fix the par- 
ticular market price which exists at any one time to an inquiry 
into the operation of certain slowly acting movements and 
tendencies. 

The demand side of this problem need not detain us. De- 
mand will change with changes in incomes, tastes, fashions, 
and the like. The effect of these influences is so obvious that 
it may be taken for granted. The supply side of the problem, 
however, needs further study. The potential supply of the 
present is limited by conditions set by past industry. The 
amounts of different kinds of consumption goods that are 
ready for present use depend upon the direction which the 
work of production has taken in the past. What, in the long 
run, is the relation between supply and exchange value? 

Prices and the Expenses of Production. — The dominant 
motive that guides farmers and business men in their invest- 
ments of labor and capital is the desire for money profits. (By 
profits we here mean the difference between the expense in- 
volved in producing goods and the money that is obtained for 
them.) If it were always an easy matter for business men to 

167 



1 68 OUTLINES OF ECONOMICS 

change their interests and their energies from one line of pro- 
duction to another, and if capital and labor could likewise be 
freely transferred from one undertaking to another, it is hard 
to see how profits in any one competitive industry could be for 
any length of time much higher than in other competitive 
industries. Managerial ability, labor, and capital would gravi- 
tate always toward those employments which promise the 
greatest profits. The effect would be a continual movement 
toward equality of advantage in different fields of industry. 
This does not necessarily mean an equality of profits as between 
individuals in any given line of business, for the amount of 
profits depends largely upon the ability and enterprise of the 
individual business man. But in a state of free competition, 
with alternative business opportunities as free and open as we 
have assumed, the profits of any business undertaking would 
hardly be larger, for any period of time, than the business man 
could get as salary by working for others, — for if working for 
others offered a greater return than assuming the risks of busi- 
ness for himself, he would naturally choose the salaried position, 
and vice versa. Purely competitive profits, under conditions of 
this absolute " fluidity " of business ability, of labor, and of 
capital, would thus tend to adjust themselves, according to the 
ability of the individual business man; that is, to equal what 
we shall later describe as the " wages of management." If we 
include the value of the business man's services, thus measured, 
among the expenses of production, we may, obviously, state 
the tendency which we have described as a tendency toward the 
equality of the prices received for the products of any particular 
industry and the expenses of producing them. 

The assumptions we have made do not, however, exactly cor- 
respond to the conditions of actual business. Managerial 
ability, labor, and capital are all specialized to a greater or less 
extent, so that they cannot be changed from one employment 
to another without loss of efficiency. But it is not necessary 
for the validity of our analysis that all managerial ability, all 
labor, and all capital should be fluid enough to change from 
industry to industry economically. There are always many 



VALUE AND PRICE 1 69 

business men who are anxiously watching for the most inviting 
business opportunities; there is always a certain amount of 
labor awaiting the most remunerative employment, and there 
is always a certain amount of money awaiting investment in 
those forms of capital goods which promise the greatest return. 
These facts are enough to give substantial truth to the state- 
ment that in any competitive industry the price of the com- 
modity produced tends to equal the cost of producing it. When 
the price of bicycles was high, as compared with the expense of 
producing them, existing bicycle factories were extended and 
new ones were built. The supply of bicycles was thus so 
increased that they could not be sold except at a much lower 
price. On this account and because of the cessation of demand, 
the profits in the manufacture of bicycles became relatively 
low, and many former bicycle factories are now used for other 
purposes. If the excess of the price of wheat over the expense 
of producing it promises to be greater than the excess of the 
price of corn over the expense of producing it, farmers will 
raise less corn and more wheat, and the result will be higher 
prices for corn and lower prices for wheat. 

Normal Price. — Because the market price of a commodity 
cannot get very far away from the expense of producing it 
without resulting in abnormally high or abnormally low profits, 
and because the existence of abnormally high or abnormally low 
profits sets forces at work which are very sure to move the price 
closer to the expense of production, the name normal price is 
given to that price which is just equal to the expense of producing 
a unit of a commodity. 

The effectiveness of the tendency of actual competitive prices 
to equal normal prices depends very largely upon the length 
of the period of time that is taken into consideration. The 
longer the period of time, the larger will be the proportion of 
managerial ability, labor, and capital that can be shifted from 
the less profitable to the more profitable undertakings. To 
build and to eqUip new factories and to extend old ones takes 
time; the supply of skilled labor in any occupation can often 
be increased but slowly, for many trades involve an appren- 



lyo OUTLINES OF ECONOMICS 

ticeship of three or more years. In the undertakings that are 
becoming less profitable, although capital specialized in the 
form of machines may not be useful for other purposes, yet such 
machines need not be replaced as they wear out ; while a skilled 
laborer cannot take up another trade without loss of efficiency, 
yet an increasing proportion of the incoming supply of laborers 
may begin their apprenticeship in those occupations in which 
there is a greater demand for labor. 

While the conditions of long-period supply are thus such as 
to result in a constant movement toward the equalization of 
market price and normal price, it may easily happen that the 
two will never become identical. For market prices them- 
selves are constantly changing under the influence of changing 
demand. And the increase in the output of an especially profit- 
able product is often overdone. Periods of losses or of low 
profits may succeed periods of high profits. In short, the goal 
toward which business enterprise directs productive efforts is 
constantly shifting. 

Different Conditions of Supply. — A fact of prime im- 
portance is that the expense of production {per unit) often varies 
as the amount produced is larger or smaller. But this relation 
between the amount of goods produced and the expense of 
producing them is different for different industries. In partic- 
ular, three forms of productive undertaking may here be dis- 
tinguished : those in which increased production is accompanied, 
in the long run, with (i) increasing, (2) decreasing, or (3) con- 
stant expense per unit of product. 

I. If transportation facilities, the knowledge of agricultural 
methods, and other controlling conditions remain unchanged, 
the amount of wheat raised in the United States cannot be sub- 
stantially increased without resort to lands less well adapted 
to the production of wheat, or the more intensive cultivation of 
lands already in use. Either alternative requires (as will be 
shown in a later chapter in more detail) the use of relatively 
more labor and capital per bushel in producing the additional 
wheat than was required for the wheat produced under the for- 
mer conditions. This means that the production of wheat 



VALUE AND PRICE 171 

cannot be substantially increased except at an increased ex- 
pense per bushel. When this condition of increasing expense is 
met with — and it holds true generally in agriculture — normal 
price increases with an increase in production. If the price 
of the product is not high enough to repay the cultivation of the 
poorest lands used, they will cease to be cultivated. If the 
price of the product is appreciably higher than the expenses of 
cultivation, farmers will find it profitable to push cultivation 
still farther, up to the point where the expense equals the price. 
2. In some industries, however, an increase in production 
will often bring forces into operation that will result in smaller 
expenses of production per unit of product. Where this condi- 
tion of decreasing expense is found, a general increase in produc- 
tion brings, in the long run, a decrease in the normal price of 
the product. What is the nature of these economies that some- 
times attend an increase of production? We rule out of con- 
sideration such things as new inventions and the general prog- 
ress of industrial knowledge and technique, for although these 
things reduce the expenses of production, they are in no direct 
way a necessary result of an increasing output. They play 
a part, moreover, in agriculture (where they help to counteract 
the effects of the rule of increasing expenses) as well as in in- 
dustries of decreasing expenses. Additions to our knowledge 
of ways of producing things are undoubtedly stimulated by the 
growth of production, which gives increased scope and impor- 
tance to improvements in industrial technique ; but for the 
purposes of the present inquiry we must put these things aside 
and merely assume a given state of industrial knowledge. The 
economies that create the condition of decreasing expenses are, 
properly understood, only such as are brought about, in a 
fairly direct way, by the increase of production itself. Here we 
must distinguish two things : first, economies in the general 
organization of whole industry, and, second, economies result- 
ing from an increase in the size of the individual business 
establishments within the industry.^ 

1 These are named by Professor Alfred Marshall "external economies" and 
" internal economies." 



172 OUTLINES OF ECONOMICS 

The most important of the first of these two classes of econo- 
mies is a greater specialization or division of labor within the 
industry. The different processes in the operations of the in- 
dustry may be separated and apportioned to different specialized 
plants, located, perhaps, at particularly advantageous points. 
Opportunity is given for a more thoroughgoing and more 
efficient specialization of labor and for the use of highly special- 
ized machinery. Subordinate industries may be developed, 
supplying machinery and other equipment ; improved trans- 
portation facilities of one kind and another may be secured. It 
becomes, in general, more feasible for the industry to utilize 
what are known to be the best and most economical methods of 
production and to keep pace with the advance of technical 
knowledge. Indirect, roundabout ways of doing things, involv- 
ing a thoroughgoing subdivision of processes and the use of 
large amounts of fixed capital in the form of elaborate plants 
and expensive machinery are advantageous only when the 
industrial output is large. All these things have played an 
important part in the progress of most of the great manufac- 
turing industries, and in making their products cheaper. 

Unless some obstacle, some countervailing force, prevents, 
these economies are sufiicient to make almost any large and 
growing industry one of decreasing expenses. And about the 
only obstacle that can stand in the way is the limitation of 
the supply of one of the necessary factors in production. The 
supply of capital has (as shown by the interest rate) kept pace 
with industrial demands. The industrial output has increased 
more rapidly than has the supply of labor, but in most industries 
this has not been sufficient to offset the movement toward 
decreasing expenses. But the supply of land and of natural 
products of various kinds is definitely limited. This is why 
agriculture, despite the fact that it benefits by some of the 
economies of specialization, is not an industry of decreasing 
expenses. For the same reason the lumber industry and petro- 
leum industry have had to contend, in recent years, with in- 
creasing expenses. 

The second class of economies — those connected with the 



VALUE AND PRICE 1 73 

increasing size of the individual business unit — are usually 
named " the economies of large-scale production." These are 
of interest to us at the present stage of our study only in so far 
as large-scale production is in itself a result of the general growth 
in the volume of the output of an industry. Other things, such 
as the invention of new and effective " large-scale " methods of 
production and the cheapening of transportation (broadening 
the market open to a particular plant), have cooperated in 
stimulating the growth of large establishments. Our present 
inquiry is merely into the relation between the increase in the 
total amount of goods produced and the expense of producing 
them ; that is, into the long-run relation between supply and 
normal price. And so our question is : Does a larger output 
for an industry at large encourage the growth of large individual 
establishments by increasing any advantages they may have 
over smaller establishments? It is clear that there is no in- 
variable rule here, for in agriculture and in some special fields 
of manufactures and trade the average size of the individual 
undertaking is not increasing, despite the rapid growth of the 
total volume of output. But in nearly all the industries in 
which we have any reason to suspect the presence of the rule of 
decreasing expenses we find that the average establishment has 
been growing larger. This must mean that in many industries 
the first class of economies, already described, can best be util- 
ized by relatively large establishments. 

Whatever the real " economies of large-scale production " 
may be (and they will be discussed in the following chapter), 
they cannot in themselves be adequate to bring about, in any 
competitive industry, the general condition of decreasing ex- 
penses. Wherever the advantages of large-scale production 
are increasing, the principal effect must be merely to divide the 
aggregate operations of the industry among a somewhat smaller 
number of establishments than would otherwise be found. But 
the growth of the size of the business establishment has no direct 
bearing upon the existence of the condition of decreasing ex- 
penses in the industry at large, except in so far as an increase 
in the size of the individual establishment is found to be one 



174 



OUTLINES OF ECONOMICS 



of the ways of utilizing to best advantage the various economies 
made possible by the increased industrial product. Large- 
scale production does not create the condition of decreasing 
expenses, but it may be an indication, a manifestation of the 
presence of that condition.^ 

3. In many hand industries, such as tailoring and cigar 
making, the expense of production per unit does not vary to any 
great extent with the amount produced. These are, therefore, 
industries with constant expenses. 

Figures 1,2, and 3 illustrate the relation of changes in supply 
to changes in price under the conditions of increasing, decreas- 
ing, and constant expenses, re- 
spectively. These diagrams 
must be carefully distinguished 
from the supply curve described 
in the preceding chapter, which 
related only to the conditions 
of supply at a particular time. 
They indicate the way in which 
an increased output, evoked by 
an increase in demand, will, in 
the long run, be offered to the 
market at higher, lower, or constant prices, depending upon the 
conditions existing in different classes of industries. In an in- 
dustry of decreasing expenses (Figure 2), for example, OM 
units of product per year cannot be supplied to the market at 
a lower price per unit than PM. But, allowing time for the 
necessary reorganization of the industry, OM' units per annum 
can be supplied at a lower price, P'M' . In an industry of in- 
creasing expenses this relation between price and amount of 
output is reversed. 

Fixed and Variable Expenses. — There is no better illustra- 

1 We have thought it worth while to emphasize the merely indirect relation be- 
tween the economies of large-scale production and the so-called "law" of decreasing 
expenses (or "increasing returns"), because there is much confusion of thought on 
this matter. Only when an industry is controlled by a monopoly, are the real econo- 
mies of a large industrial output identical with the "economies of large-scale pro- 
duction." 




VALUE AND PRICE 



175 




Fig. 



tion of the necessity of keeping definite periods of time in mind 
when discussing problems relating to valuation than that 
furnished by the problem of the apportionment of specific 
expenses of production to par- y 
ticular units of products. In 
almost any industrial establish- 
ment, any increase in product 
will be attended by some specific 
increase in expenses : more raw 
material and more labor will be 
used, possibly more power; 
although the increased expenses 
for labor and power may not 
be proportionate to the increase 
in production. Such expenses are called variable expenses, and 
are to be contrasted with, fixed expenses, which remain approx- 
imately the same, no matter what the amount produced is. 
The interest on the funds invested in the factory building 
and its equipment of machinery is a fixed expense ; the expense 
of management and general office expenses will not usually 
be increased proportionately by an increase in the annual 
product of an establishment. 

It is often assumed that wherever only a part of the expenses 

varies with the amount pro- 
duced, the establishment is 
ipso facto one in which large- 
scale production is especially 
economical. Whether this as- 
sumption holds true or not 
often depends on the scale of 
production we have in mind. 
Factories and other plants are 
built with a certain maximum 
capacity, and until that maxi- 
mum capacity is utilized, production may be increased without a 
proportionate increase in expenditure. But when the maxi- 
mum is reached, more equipment, and often more buildings, will 




176 



OUTLINES OF ECONOMICS 



be needed before there can be a further increase in product. 
There is often a certain most efficient size of plant ; an increase 
in business beyond the capacity of the most efficient size of plant 
necessitates either a curtailing of the business or a duplication 
of the plant. When business conditions are such as to warrant 
temporarily pushing the output of a plant beyond its normal 
capacity, the result usually is, as every manufacturer knows, 
that this increased output is produced uneconomically, that is, 
at relatively increased expenses of production. 

Many seemingly constant expenditures (like interest on the 
cost of the plant) are variable in the long run. Such expendi- 
tures increase, but only at considerable intervals of time, as 
^ additional invest- 

ments in fixed cap- 
ital are made. A 
long-period supply 
curve correspond- 
ing to the condi- 
tions of production 
in such a business 
might be some- 
thing like Figure 
4. This diagram 
should be inter- 
preted as follows: 
The total expense of producing a certain output, OM, is repre- 
sented by the area OMPS. MP (considered not as a mere line, 
but as an indefinitely narrow area) represents the variable ex- 
pense which would not be incurred if the volume of production 
were a little smaller than OM units. MP, then, represents the 
marginal expense, in this particular establishment, of producing 
OM units. Thus the irregular curve SS' represents the way in 
which the aggregate expenses of production are increased as the 
output (measured on the line OX) grows. When the product 
reaches OM' units, and again when it reaches OM" units, 
fresh investments of large amounts of capital are necessary. 
From the long-time point of view, such a business might very 




M' 



M" 
Fig. 4 



-X 



VALUE AND PRICE 177 

possibly be one of approximately constant expenses ; although 
of course some of the real economies of large-scale production 
might be present and might result in decreasing expenses. 

The Relation of Fixed and Variable Expenses to Price. — The 
fact that, within limits, the expenses of a business undertaking 
do not increase proportionately as the output increases has an 
important bearing upon competitive price-making. The pro- 
prietors of a "business establishment will feel justified in in- 
creasing their output, provided the additional output will sell 
for enough to afford some profit above the actual amount by 
which it increases their expenses. If the full capacity of their 
plant is not already utilized, they will count as profit any addi- 
tional income they can secure above the necessary increase in 
variable expenses. If they are producing some staple commod- 
ity for the general market, so that they cannot discriminate 
in the prices at which they sell to different buyers, they will 
find it difiicult to make much use of this possibility of cutting 
prices on part of their output. But if they are producing a 
variety of goods, if they are making highly specialized products 
" to order," or if they are selling in two or more widely separated 
markets, they may often be able to increase their output by 
accepting prices too low to contribute anything to the payment 
of their fixed expenses. This is often the explanation of the 
" dumping " of part of a manufacturer's product on a foreign 
market at a lower price than he charges at home. Railways are 
able to take advantage of the fact that (for the time being) 
only part of their expenses vary with their trafiic, for they do 
not have to charge a uniform rate per ton per mile, but can 
classify their rates according to the origin, destination, and 
nature of the' traffic. The rates charged by electric plants are 
often less for current used at certain hours of the day when the 
capacity of the plant is only partly utilized. The reader will 
probably be able to supplement these illustrations with others 
based upon his own observation. 

If a business establishment is hard pressed by competition, 
or if for any other cause, such as a dull season, its sales are 
small, its proprietors may decide to cut prices on their whole out- 

N 



178 OUTLINES OF ECONOMICS 

put to a point that will cover the variable expenses and possibly 
contribute something toward meeting the fixed expenses. Some 
fixed charges, like depreciation, interest, rent, insurance, taxes, 
will continue even if the output is little or nothing. It will very 
likely be sound business policy to make the best of a bad situa- 
tion by getting what little income can be had over and above 
the variable expenses of production. Much money may have 
been irrevocably invested in the business, and although possibly 
under no conditions can it be made to yield the return that had 
been expected at the time when the investment was made, 
matters will not be bettered by letting the plant lie idle. It may 
be that the prices which the proprietors of the business thus 
reluctantly decide to accept are high enough to pay all the ex- 
penses of production, fixed and variable, in some competing 
plants, better organized or more favorably located. Or it 
may be that some or all of the competing plants also' find it 
necessary to accept prices that do not cover their fixed expenses. 
Sometimes the fact that it is more profitable to produce at 
prices which cover merely the variable expenses than not to 
produce at all leads some one establishment to cut prices. Other 
establishments have to reduce prices in order to protect them- 
selves, and a period of cut- throat competition may ensue. 

Though at any given time it may be the variable rather than 
the aggregate expenses of production per unit of product which 
fix the price at which some or all of the different establish- 
ments in an industry are selling their products, it should not be 
inferred that it is the variable expenses alone which measure 
the normal price of a product. For in the long run prices have 
to be high enough to induce the replacement of fixed capital as 
it wears out and (in a growing industry) to attract new perma- 
nent investments of capital. That is, in the long run, prices 
have to be high enough to cover both variable expenses and 
fixed expenses, — which last, as we have seen, are generally 
variable as seen through a sufficiently long period of time. As 
a matter of fact, the prices in any large competitive industry 
are usually high enough to more than cover the expenses of 
production in the most efi&cient establishments, but are rarely 



VALUE AND PRICE 1 79 

high enough to cover all such expenses in the least efficient 
establishments. For the time being the weaker establishments 
may continue in operation, but sooner or later they are sure 
to be forced out. The better establishments will be enlarged, 
and new and possibly yet more efficient ones will be built. If, 
however, none of the establishments in an industry is able to 
cover all of its expenses, the volume of output must eventually 
decline to a point where prices can be secured that will cover 
interest, depreciation, and the other fixed expenses that must be 
provided for if the recurrent needs of the industry for fresh 
investments in fixed capital are to be met. It is in these ways 
that the tendency of prices to equal the expenses of production 
manifests itself. 

Joint Expenses of Production. — When the production of one 
commodity is inevitably accompanied by the production of one 
or more other commodities, it is often impossible to assign a 
definite part of the total expense of production to any one of 
the commodities. It is impossible to separate the expenses of 
producing tenderloin steaks from the expenses of producing 
soup bones, or either one of these from the expenses of producing 
hides. Mutton and wool, cotton and cotton seed, coal gas and 
coke, are familiar examples of commodities produced under 
conditions of joint expense. Modern methods for the utiliza- 
tion of industrial by-products have greatly increased the list of 
commodities produced under such conditions. 

What is the normal price of these jointly-produced commod- 
ities ? Take first the simplest case : that in which all the 
expenses of producing two commodities are joint expenses. 
Neither commodity can be said to have a normal price of its 
own, for neither commodity has specifically assignable expenses 
of production of its own. But the two commodities, taken 
together, have what may be called a collective normal price. 
Suppose, for example, that the production of every unit of one 
commodity is necessarily accompanied by the production of 
two units of the other commodity. It is evident that in order 
to induce the production of these commodities the price of a unit 
of the first commodity plus the price of two units of the second 



l8o OUTLINES OF ECONOMICS 

commodity must cover the joint expense of producing these 
three units. This joint expense, then, measures the collective 
normal price of the three units. Just how the market prices 
which, in their sum, will tend to approximate this collective 
normal price, will be fixed, will depend upon the conditions of 
demand for each of the two commodities. Sometimes one or 
both of the jointly produced commodities will have to compete 
in the market with substitute commodities produced under 
other conditions, and this, of course, tends to limit the possible 
range of price variation. 

When, as often happens, two commodities are produced under 
conditions of partially joint expenses, further processes being 
necessary to fit each commodity for the market, the price must 
in each case cover the specific or assignable expense. The 
joint expenses will be assigned to one or the other of the commod- 
ities, or apportioned between them, according to the relative 
demand for them. So far as the expenses are joint they are in 
some respects similar to the fixed expenses of any establishment 
producing under the ordinary conditions of fixed and variable 
expenses. In a sense all fixed expenses are the joint expenses 
of producing the different units of output, while all variable ex- 
penses are specifically assignable to the different units of the 
product. But this analogy must not be pushed too far, and that 
for two reasons: (i) Most establishments with fixed and va- 
riable expenses have to accept one uniform price for the different 
units of their product. Their fixed charges, unlike true joint 
expenses, cannot be covered by the price of one portion of the 
output and disregarded in the price of another portion. (2) Even 
if an establishment is producing two or more different commodi- 
ties or is able to sell one commodity in two or more different 
markets at different prices, its fixed expenses are not true joint 
expenses except in so far as its output is necessarily accompanied, 
without additional expense, by the production, or partial pro- 
duction, of another part of their output. The importance of 
this is that, as we have seen, an increase or decrease in the 
aggregate product of an industry must ultimately increase or 
decrease the fixed expenses of that industry. Fixed expenses 



VALUE AND PRICE l8l 

thus enter in the long run into the determination of the normal 
price of all portions of the industry's output. This is not true of 
joint expenses, for these affect only what we have termed the 
collective normal price of the joint products. Thus neither steaks 
nor hides have a separate normal price. But each standard 
grade or type of product in the output of the furniture industry 
has a normal price of its own. 

The Surplus of Bargaining. — Demand and supply do not 
always fix price at a definite point. The price of horses of any 
given grade, for example, is fixed only approximately by market 
conditions. In the sale of a horse there is room for considerable 
latitude of opinion as to the price that should be paid. If 
the lowest price that the seller will take is considerably below 
the highest price that the buyer will give, just where between 
these limits the actual price will be finally fixed will depend 
upon the relative skill at bargaining of the seller and buyer. In 
the case of a horse trade, this opportunity for the " higgling of 
the market " has become proverbial, and in many other kinds 
of exchanges the efficient bargainer has an opportunity to get 
for himself a surplus above his minimum selling price, or below 
his maximum buying price. Real estate transactions furnish 
a good example. In the case of the great commodities of the 
world market, like wheat, cotton, and iron, the price is set so 
accurately by market conditions that the gains of bargaining 
are relatively small. In general, the wider the market, the more 
general the use of the commodity, the greater the ease with which the 
commodity can he sorted into standard grades (as in the case of 
wheat and cotton) , the more accurately will competitive forces fix a 
definite price. Goods which cannot he standardized, each unit of 
which possesses some unique qualities, give most scope for the varia- 
tions in the valuations of individual huyers and sellers. In such 
cases supply and demand do not fix a price point, but only cer- 
tain limits within which the price must fall. The widening of 
the market, however, and the increasing standardization of 
commodities — an effect of machine production — are bringing 
a larger and larger proportion of goods into the field where 
uniform market valuations dominate. 



182 OUTLINES OF ECONOMICS 

Non-reproducible Goods. — Some economic writers have 
made a special class of such goods as great works of art. These 
are absolutely unique, in that no copy can have anything like 
the value of the original. The price of such non-reproducible 
goods has an upper limit fixed by the highest subjective valua- 
tion set upon it by any possible buyer. The lower limit will 
be either the seller's own subjective valuation, or the second 
highest valuation set by any competing buyer, according as 
one or the other of these two is the higher. Between the upper 
and lower limit the exact fixing of the price is a matter of pure 
bargaining. Such cases should not be confused with monopoly 
price, as has been done by some writers. The products of almost 
all the industrial handicrafts, as well as the products of the 
avowedly artistic pursuits, possess a non-reproducible element 
of individuality, that removes them to a greater or less extent 
from the operations of the law of normal price. A commodity 
may possess this quality of uniqueness to such an extent that 
it is not affected at all by the forces determining the value of 
the general class of goods to which it belongs, and in this case 
its owner may be said to have a monopoly of it. But it is 
better to look upon the valuations of such non-reproducible 
goods as determined by individual valuations and the process 
of bargaining. The " normal " price of such goods is simply the 
highest price that can be got for them — a statement which 
does not hold true of most monopoly goods. For monopoly 
goods are not necessarily unique or non-reproducible. They 
differ from ordinary competitive goods, however, in that they 
cannot be reproduced except by the monopolist. 

Retail Prices. — The retail prices paid by the individual con- 
sumer do not always respond to all the variations in wholesale 
prices brought about by changes in supply and demand. There 
are sometimes tacit or explicit local price agreements between 
local merchants, which apply even to competitively produced 
goods. Some retailers consistently sell a few kinds of goods at 
less than cost to attract custom for the goods on which they 
may make a profit. Merchants who make a specialty of a 
high class of goods, and thus cater to a wealthy clientele, are 



VALUE AND PRICE 183 

apt to exact higher prices for ordinary goods than do those 
merchants who have to deal with a poorer class of customers. 
Custom has more effect on retail than on wholesale prices. The 
prices of various articles sold as " men's furnishing goods " 
form a good example of the influence of custom. Retail prices 
are also governed by the value of the coins that are in general 
use, and are generally expressed in round numbers. In the 
long run, demand and supply govern retail prices, but they do 
not set a definite price point so accurately as they do in the case 
of wholesale prices. 

Public Authority and Value. — In the Middle Ages there was 
considerable speculation by theologians and legists about the 
subject of " just price " — the value at which things ought to 
exchange for other things. This idea denotes an important 
difference between the medieval and modern concept of value. 
Professor Ashley has put it clearly in these words : " With Aqui- 
nas, the greatest of the medieval schoolmen, it [value] was some- 
thing objective ; something outside of the will of the individual 
purchaser or seller; something attached to the thing itself, 
existing whether he liked it or not, and that he ought to rec- 
ognize. And as experience showed that individuals could not 
be trusted thus to admit the real value of things, it followed that 
it was the duty of the proper authorities of state, town, or gild 
to step in and determine it, and what the just and reasonable 
price really was." This " just and reasonable price " was very 
often thought to be that price which would afford a reasonable 
compensation for the labor of the producer. When in more 
modern times theological speculations began to yield prece- 
dence to inquiries into " natural laws," the idea of just price 
was supplanted by the idea of " natural price." Sometimes 
this was interpreted as determined by the value of the labor put 
into a commodity (this was the dominant idea during the eight- 
eenth century), but the growth of capitalistic production 
necessitated the recognition of the other elements in the expense 
of producing a commodity as part of its natural price. Modern 
economic science, as we have seen, applies the term " normal 
price " to the expense of producing a thing, but interprets it 



1 84 OUTLINES OF ECONOMICS 

only as an important factor controlling the long-period fluctua- 
tions of market prices. The adjective " natural/' with its mis- 
leading implications, has been abandoned. Yet the competitive 
system is today so thoroughly accepted as the " natural " 
economic order, that there is, as we have previously noted, a 
deep-seated conviction that normal competitive prices (meas- 
ured by the expenses of production) are natural and just prices. 
This conviction is, however, brought face to face with the fact 
of the growth of a large industrial field in which monopoly, 
rather than competition, rules. The question of just price is 
again a live issue — as it was before the growth of the com- 
petitive system. Public authority is frequently invoked to 
insure that the prices fixed by holders of municipal franchises 
and other monopolists are just and reasonable. The chief 
fundamental test which our courts are able to apply to the 
reasonableness of any particular price is its conformity to what 
the price would have been under competitive conditions. Thus 
it is often asked if a particular monopoly charge gives a more 
than normal return upon the capital invested. The deter- 
mination of what the expense of producing a particular com- 
modity or service really is, is often a difficult, or even impossible, 
task (the distinction between constant and variable expenses 
being frequently a stumbling-block), but, given the general 
acceptance of the competitive system, it is hard to see what 
other standard could be used. Moreover, the general consensus 
of recent court decisions is that the Fifth and Fourteenth Amend- 
ments to the Federal Constitution, prohibiting the taking of 
property without due process of law, prevent federal and state 
governments from going farther than this in the regulation of 
monopoly charges. And even this power is not conceded, 
except in the case of businesses affected with a distinct public 
interest, such as those conducted by so-called public-service 
corporations. In fixing prices for its own services, such as 
postal charges, the government is controlled by other considera- 
tions. These will be discussed in the chapters on public finance. 
Imputed Value. — The only things to which market valuations 
actually apply are the specific units of goods that are actually 



VALUE AND PRICE 1 85 

bought and sold. We are accustomed, however, to impute these 
market prices to all other existing goods of the same kinds. 
When wheat is sixty cents a bushel, the only bushels of wheat 
actually valued by the market at that price are the ones actually 
sold at that price. Yet we impute or ascribe the same value 
to all other bushels of the potential supply of wheat in the same 
market. 

Notwithstanding the hypothetical nature of this imputed 
value, it is often treated as though it were a real thing. Statis- 
tical attempts to state the wealth of a nation in terms of dollars 
and cents are only estimates of the sums of these imputed values. 
A merchant's inventory of his stock in trade is often accompanied 
by an estimate of its value. Whether this value will be realized 
or not depends upon the constancy of business conditions, the 
caprices of fashion, and whether it can be sold in the regular course 
of trade or whether it has to be disposed of at a forced sale. 
Many kinds of consumption goods, such as household furniture, 
are not customarily thought of by the owner in terms of ex- 
change value. It is often necessary for purposes of taxation to 
ascribe value to them, but this is frequently a difficult and 
somewhat arbitrary process. 

The Prices of Production Goods. — Throughout our analysis of 
exchange value it has been assumed that the commodities valued 
were wanted by consumers for the satisfaction of their wants ; 
that is, that they were consumption goods. It is not altogether 
incorrect to say that producers' goods — capital and land — 
have a marginal utility, which varies with the importance 
attached to the possession of them. While one could thus, with 
substantial accuracy, include producers' goods in the scope of 
the foregoing analysis, there is a more instructive way of ap- 
proaching the problem of the prices of land and of capital. 
Consumption goods have value because they satisfy human 
wants ; that is, they yield an income of satisfactions, while 
production goods are valued because they have the power of 
gaining a money income for the owner. Just as the values of 
consumers' goods vary with the intensity of the wants they 
satisfy, so the values of producers' goods vary with their power 



1 86 OUTLINES OF ECONOMICS 

to yield a money income. The problem of the prices of pro- 
ducers' goods will, accordingly, be discussed in the chapters 
on the rent of land and the interest on capital. 

Other Theories of Value. — The older economists used to em- 
phasize the relation between the price of a thing and the amount 
or the expense of the labor spent in producing it, — a relation 
much closer under the old methods of hand production than it 
is at present. The development of a systematic labor theory 
of value was, however, the work of Karl Marx, the founder of 
modern " scientific " socialism. This theory is, in essence, that 
labor produces all value and that the interest on capital and the 
rent of land are deductions from the real wages of labor — de- 
ductions that are made possible only by the existence of the 
system of private property in producers' goods. It is so ob- 
vious that things do not exchange today in proportion to the 
amount of labor involved in producing them, that to point this 
out in detail, as some economists have done, is unnecessary. 
Karl Marx himself recognized that his " values " were not 
measured by the actual prices of the market. They seem to 
hive been conceived as some mysterious essence or quality in 
things. But the only economic values that can be recognized 
from the modern scientific point of view are the values that 
really exist — the actual values of the market. Nor can we 
say that things ought to exchange in proportion to their labor 
costs, without begging the whole question in favor of the aboli- 
tion of private property in land and capital. Moreover, it 
will be shown later that rent and interest would not be elim- 
inated, although they might be changed in form, by a change 
from private to common ownership of producers' goods. Al- 
though the labor theory of value is still held by many followers 
of Marx, its place in the creed of scientific socialism is diminish- 
ing in importance. 

The relation between price and the expenses of production 
has sometimes been stated in such a way as to lead to the infer- 
ence that cost of production is the cause of value. The expense 
of production theory of price, when so stated, is open to much 
the same objections as the labor theory. Suppose I perfect a 



VALUE AND PRICE 187 

machine at the expense of ten thousand dollars which will blow 
soap bubbles at the rate of a thousand an hour. Will it be 
worth ten thousand dollars ? Certainly not ; but why not ? 
The theory of costs will not explain it. To say that the labor 
and materials have not been wisely used is simply to say that 
the machine has no value, which is just what we are trying to 
explain. As a fact, it is not worth ten thousand dollars simply 
because no one is willing to give ten thousand dollars for it. 
The expenses of production do not create value, but there is a 
sense in which price is the cause of the expenses of production. 
That is, men think it worth while to expend money in producing 
things because they think that the products will sell for 
enough to recompense them for the expenses of production. 

Many of the economists who have written in the past about 
the subject of price took the facts of demand for granted, and 
devoted most of their treatment of the subject to an examina- 
tion of the relation between price and the expenses of produc- 
tion. This was in part an expression of a general tendency to 
regard the production of wealth as something to be desired for 
its own sake ; the fact that the satisfaction of human wants is 
the real goal of most economic efforts being underemphasized. 
In more recent years economic writers have developed the analy- 
sis of human wants ; the fact that utility in the economic sense 
is not utility in general, but the utility of a particular unit of a 
commodity, being the most significant point in this new analysis. 
Some writers have even gone so far as to take the facts of supply 
for granted, and to assume that price is explained when mar- 
ginal utility is described. As a determining cause of price, 
utility has a logical priority over scarcity, in the sense that 
demand is usually the cause of supply. Yet in the analysis of 
the actual price-making process we have to recognize that util- 
ity and scarcity, demand and supply, are forces operating simul- 
taneously, neither of which can be neglected without obscuring 
the fundamental facts of the market. 



OUTLINES OF ECONOMICS 



QUESTIONS 

1. Is there any relation between the price of a lead pencil and the expense 
of producing it? 

2. What elements of a farmer's expenses are "constant"? What are 
"variable"? 

3. What different possible standards of just price can you suggest? 

4. Combine demand curves with long-period supply curves like those 
shown on page 175 (the general conditions of demand being assumed to 
be constant) and interpret the meaning of the resulting diagrams. 

5. Are the passenger service and the freight service of a railway joint 
products? 

6. What different possible meanings can be attached to the expression 
"natural value"? 

6. Discuss the following statement : 

"The fact is that labor once spent has no influence on the future value of 
any article ; it is lost and gone forever. In commerce bygones are forever 
bygones ; and we are always starting clear at each moment, judging the 
value of things with a view to future utility." — Jevons, Theory of- Political 
Economy, p. 164. 

REFERENCES 

Chapman, S. J. Outlines of Political Economy, Chaps, xv-xvii. ■ 

Flux, A. W. Economic Principles, Chaps, iv and v. 

Marshall, Alfred. Principles of Economics, 6th ed.. Book v. Chaps. 

ii-viii, xi. 
Mill, J. S. Principles of Political Economy, Book iii, Chaps, iii and iv. 
Taussig, F. W. Principles of Economics, Vol. i, Chaps, xii-xiv, xvi. 
WiESER, F. VON. Natural Value, Book v, Chaps, i-vi. 



CHAPTER XII 
MONOPOLY 

The Idea of Monopoly. — One of the economic terms most fre- 
quently used nowadays is monopoly, and at the same time it 
is one of those terms which are peculiarly vague and ill-defined 
in popular discussion. Even in law and economics, contradic- 
tory meanings have been attached to the term, although recently 
there has been a marked clarification of thought both on the part 
of economists and jurists. While there has been confusion of 
thought with respect to monopoly, all have agreed that some- 
thing to be called monopoly has existed, and that it has been 
the cause of perplexing scientific and practical problems. 

In economics, as in life, categories shade off into each other, 
and at the boundaries discrimination is difficult. It is best, 
therefore, to find highly developed, plainly marked types to fur- 
nish us the subject-matter for definition and to compare one type 
with another. This is an especially desirable mode of procedure 
in the present case, because the term " monopoly " at once sug- 
gests the term " competition," with which it is inevitably con- 
trasted. When monopoly exists, competition is thought of as 
absent. A state of full and free competition, on the other hand, 
is incompatible with monopoly. 

Competition means a market with rival sellers and buyers, 
and prices determined, on the one hand, by efforts of sellers, 
acting independently of one another, to dispose of commodities 
and services, and on the other hand, by efforts of purchasers, 
acting independently of one another, to secure commodities and 
services. We have seen the forces that under competition limit 
producers and purchasers, and thus determine prices, and we 
have seen that competitive prices are beyond the control of any 
one buyer or seller. 



igo OUTLINES OF ECONOMICS 

Monopoly, as the term contrasted with competition, means 
combination and unified action, signifying restraint on the free 
offering of commodities and services by rival sellers and on the 
free purchase of these commodities and services by rivals who 
desire to secure them. The word " monopoly " itself means a 
condition in which there is a single seller or a single purchaser, 
and signifies unity in management of some kind of business in 
some essential particular. 

The particular in which unity is secured in the case of monop- 
oly may be in production, it may be in sales, it may be in pur- 
chases ; or it may be in any two or all three of these particulars. 
This use of the term " monopoly " gives us a clear scientific 
concept which is workable ; and on its basis we may then formu- 
late this definition of monopoly : Monopoly means that substan- 
tial unity of action on the part of one or more persons engaged in 
some kind of business which gives exclusive control, more particu- 
larly, although not solely, with respect to price. 

This definition of monopoly is in accordance with good English 
usage, and is also in harmony with the meaning given to the 
corresponding word in other modern languages by those who 
use these languages with discrimination. In legal utterances, 
too, though they have been contradictory and inconsistent in 
various particulars, we find, nevertheless, a sound tendency to 
emphasize unified control of business as an essential character- 
istic of monopoly.^ 

The Idea of Monopoly and Industrial Evolution. — But the 
meanings of economic categories change with industrial evolu- 
tion. Even such terms as freedom and liberty have to be newly 
interpreted with every new stage and even with every marked 

1 Lord Coke, in the seventeenth century, said that monopoly consisted of power 
granted "to any person or persons, bodies politic or corporate, for the sole buying, 
selling, making, working, or using of anything, whereby any person or persons, bodies 
politic or corporate, are sought to be restrained of any freedom or hberty that they 
had before, or hindered in their lawful trade" (3 Instilulcs, iSi). Blackstone, in his 
Commentaries on the Laws of England, gave almost precisely the same definition in 
the following century. The Supreme Court of the United States {National Cotton 
Oil Co. V. Texas, 197 U. S. 129) has accepted the definition of monopoly given in 
the text, above. 



MONOPOLY 191 

phase in a stage of economic life. Naturally monopoly has 
acquired a new significance, requiring new interpretation. The 
earlier legal definitions made monopoly proceed from an express 
grant of public authority. Lord Coke says: "A monopoly 
is an institution or allowance by the king, by his grant, commis- 
sion, or otherwise " ; and Blackstone uses similar language in 
defining monopoly " as a license or privilege allowed by the 
king." 

Historically, this source of monopoly power is of paramount 
importance. From early times, English sovereigns granted mo- 
nopolies either for public or private reasons, and they became a 
grievous burden. Queen Elizabeth, in particular, sinned in this 
respect, regarding the right to grant monopolies as " one of the 
fairest flowers " in her prerogative, and it was not long before 
the citizen found himself restrained and shut in on every side by 
a privileged class of monopolists. In 1603, it was decided, in a 
famous case, with respect to one of Queen Elizabeth's grants : 
" That it is a monopoly and against the common law. All 
trades as well mechanical as others which prevent idleness (the 
bane of the Commonwealth) and exercise men and youth in labor 
for the maintenance of themselves and their families, and for 
the increase of their substance to serve the Queen when occasion 
shall require are profitable for the Commonwealth, and therefore 
the grant to have the sole making of them is against the common 
law and the benefit and liberty of the subject." Parliament, in 
1624, passed a statute declaring that " all monopolies are alto- 
gether contrary to the laws of this realm and are and shall be 
void and of no effect." Exceptions to this rule were sometimes 
made upon one ground or another, but the general principle of 
the illegality of special grants of monopoly became thoroughly 
established in English law. 

Our forefathers were so deeply impressed with the evils which 
they had suffered at the hands of the monopolists in old England 
that in the Bills of Rights and elsewhere in the early constitutions 
of our commonwealths they frequently inserted severe denun- 
ciations of monopolies, and prohibited them unqualifiedly ; and 
these declarations and prohibitions still last in several states. 



192 OUTLINES OF ECONOMICS 

Two illustrations will suffice. We read the following utterance 
in Article 39 of the Declaration of Rights which forms part of the 
constitution of Maryland : " Monopolies are odious, contrary to 
the spirit of a free government and the principles of commerce, 
and ought not to be suffered." And the people of Texas still 
cherish Section 26 of Article i of their constitution, which among 
other things declares that " monopolies are contrary to the genius 
of a free government, and shall never be allowed." 

While the spirit of monopoly is as old as man, there was until 
this century comparatively little opportunity for monopoly on 
any large scale save as it proceeded from express grants of public 
authority. These grants were sometimes made for public pur- 
poses, and sometimes they proceeded from mere abuse of 
monarchical power, and were given to favorites of royalty. 
We cannot now stop to discuss their merits and demerits, but 
call attention to the fact that they became odious, and were 
prohibited both in England and in this country, exception being 
made of patents and copyrights. At the present time, however, 
monopolies proceed from the nature of industrial society, and 
are of far greater significance in our economic and political life 
than ever before. The really serious monopolies of our day are 
far more subtle, and have for the most part grown up outside 
of the law, and even in spite of the law. Framed with a view 
to only one kind of monopoly, our law was at first wholly inade- 
quate to cope with these new and varied manifestations of 
monopoly.^ 

Things Sometimes Confused with Monopoly. — We must dis- 
tinguish sharply between a condition of monopoly and other 
conditions, if we are to think clearly and accurately. One thing 
which does not yield monopoly ils mere limitation of supply, 

1 Modern industrial monopolies are often quite as much akin to the offense known 
in the old English law as "engrossing" as they are to the old notion of a monopoly 
granted as a special privilege. The engrosser was one who bought large stocks of 
goods in a market or on their way to a market with the purpose of selhng them later 
at a higher price. The opposition to engrossing seems to have been based partly 
on hostility to unnecessary middlemen and partly on the fear of temporary monopo- 
lies, created by "cornering the market." Later, the terms engrossing and monop- 
olizing came to be generally used as synonymous in court decisions. 



MONOPOLY 193 

and it is strange that even an economist of the ability of John 
Stuart Mill should have found the essential feature of monopoly 
in this limitation ; for this at once makes monopoly cover the 
entire field of economic activity, inasmuch as economic activity 
is for the acquisition of valuable things, and things lack value 
whenever their supply is adequate for the satisfaction of all 
wants. It is only things limited in proportion to human desires 
that have exchange value. 

Nor may we say that a valuable thing is monopolized because 
its supply is limited and also graded in quality. Land exists in 
quantities to which physical nature has assigned limits, and the 
supply of land exists in grades varying in fertility and desirability 
of situation, and as a consequence of this limitation and grada- 
tion we have the rent of land. Land is not, however, a monopoly, 
and it is misleading to speak of it as a natural monopoly. No- 
where do we find monopoly either in the ownership or in the 
cultivation of land, but everywhere competition — competition 
among unequals, to be sure, but still competition. 

Land rent is a differential gain, a gain due to the superiority of 
the land owned by rent receivers over that cultivated by those 
who are making use of land which affords nothing beyond returns 
to labor and to capital. We must distinguish between the 
broad concept of differential gains enjoyed by those in competi- 
tive pursuits, and the monopolistic gains which are based on the 
absence of competition. 

Just as sharply must we distinguish between competitive busi- 
nesses of large magnitude and monopolies. Department stores 
in no city in the world enjoy monopolies, but are subjected to the 
steady, permanent pressure of competition. There are those 
who call every business operating on a vast scale monopoly, and 
would put in the same economic category a gasworks without a 
competitor and a huge retail dry-goods establishment with rivals 
at every hand, ready to seize every opportunity for an advantage 
over it, and certain to ruin it if its managers relax their intense 
activity and watchfulness. 

Classification and Causes of Monopolies. — Monopoly ap- 
pears to-day in so many different forms and results from so many 



194 OUTLINES OF ECONOMICS 

different causes that the classification of monopohes is a neces- 
sary preliminary to clear thinking in this field. 

In the first place, we must note that there are (i) public 
monopolies, owned and operated by some political unit, for the 
benefit of the community, and (2) private monopolies, owned by 
private persons, firms, or corporations, and operated primarily 
for their own benefit. 

In the second place, monopolies may be (i) local, {2) national, 
or (3) international. This classification is more or less arbitrary, 
but it suggests that the area of the operation of a monopoly 
is a matter of much importance. There may be only one seller 
of shoes on a particular street or in a particular building. We 
do not call this monopoly, because the area in which this shoe 
dealer is without competitors is much smaller than the area in 
which the forces which fix the retail price of shoes operate. It 
is not sufiicient that one should be the only seller or buyer in a 
certain definite area. For monopoly to exist it is necessary 
that the unified control of the buying or selling of a particular 
commodity or service should extend throughout the area of the 
market, whatever that area may happen to be. The supply of 
gas, or of street railway transportation, is in most cities a real 
monopoly, because the market in such cases is merely local. 
Two young men in Chicago some years ago cornered the market 
on eggs, and thereby cleared $15,000. The weather was so 
cold that eggs could not be shipped to the city, and thus the 
speculators had a temporary local monopoly. A protective 
tariff or other impediments to international trade may some- 
times enable a monopoly to exist in one country when the same 
article or service is not monopolized in another country. Various 
attempts have been made to establish international monopolies, 
but none of these has been entirely successful. Agreements 
restricting competition between the producers of different na- 
tions are known to have been effected in the steel trade and 
in the petroleum trade. 

We pass now to a third classification of monopolies, according 
to the source of monopoly power. This classification is especially 
important, because v\^e shall not know how to deal effectively 



MONOPOLY 195 

with monopolies until we understand just why and how the 
different kinds of monopolies have come into being. 

A. Social Monopolies. 

I. General welfare monopolies. 

1. Patents. 

2. Copyrights. 

3. Public consumption monopolies, 

4. Fiscal monopolies. 

II. Special privilege monopolies. 

1. Those based on public favoritism. 

2. Those based on private favoritism. 

B. Natural Monopolies. 

I. Those arising from limitation of supply of raw ma- 
terial. 
II. Those arising from secrecy. 

III. Those arising from peculiar properties inherent in 

the business. 

Social Monopolies. — Businesses are social monopolies ^ when 

they are made monopolies not by their own inherent properties, but 

either by legislative enactment or by special advantages or privileges 

granted to them by other monopolies. 

Social monopolies cannot exist without the acquiescence of 
society. There is no reason, therefore, why social monopolies 
should be permitted, except in so far as particular social monop- 
olies are deemed to be advantageous means of achieving 
socially desirable ends. 

The exclusive privileges conferred (for limited periods) by 
patent and copyright laws are justified by the stimulus they have 
given to invention and authorship. Patents lead to several 
different kinds of monopolies. In some instances the monopoly 
is limited to the control of the supply of the patented article 
itself. In other cases the use of a patented machine or process 
in the manufacture of some other product may give advantages 
important enough to create a monopoly in the supply of that 
product. Sometimes the owner of a patent endeavors to extend 
the scope of his monopoly by refusing to sell his patented prod- 
1 Sometimes called " artificial monopolies." 



196 OUTLINES OF ECONOMICS 

ucts except on the condition that other commodities, used in 
connection with the patented product, be purchased from him 
and not from his competitors. Such agreements have been en- 
forced in the sale of mimeographs and of shoe machinery. These 
" tying contracts " were made illegal by the Clayton Anti- 
Trust Act of 1914. Again, the patent system sometimes operates 
so as to perpetuate a monopoly already established. Some new 
inventions cannot be profitably utilized except in connection 
with machines or processes which have previously been patented. 
For this and other reasons it frequently happens that an exist- 
ing monopoly affords the only market for the improved machines 
and processes adapted to some particular industry. This has 
been an important factor in the telegraph, telephone, and elec- 
trical industries. But although our patent laws need careful 
revision,^ the policy of granting inventors a temporary monop- 
oly continues to meet with general social approval. Copyrights 
stand upon even firmer ground. To do away with copyrights 
would not only lessen the incentives to authorship, but it would 
also prevent the publication of many good books. 

Trademarks, like patents, are monopolies in the strictly legal sense that 
no one else may use them. But, unlike patents, they do not lead to a 
monopoly in the economic sense of giving exclusive control of one sort of 
business. They are used largely in competitive business undertakings as 
a help in establishing and maintaining what is termed good-will. The law 
also forbids the fraudulent imitation of established brands, firm names, and 
distinctive forms of packages. In so far as a successful business man in a 
competitive field is able to induce people to believe that it is better to pur- 
chase his particular brand of goods than to take the chance of getting a 
possibly inferior quality by purchasing his competitor's products, he may 
be able to lift himself a little above the "dead level" of competition. He 
may even find that he can increase his net profits by putting the price of his 
goods somewhat higher than that at which precisely similar goods are sold 
in the market. By thus successfully marking off his product as something 
distinct from and possibly superior to his competitor's goods, he is able to 
obtain what might be termed a quasi-monopoly. But because his power 
to control the price of his product is in general much more limited than that 
of the true monopolist, and because competition limits and conditions his 
activities in other ways, his business is more properly called competitive 
than monopolistic. 

* See p. 23, above. 



MONOPOLY 197 

Public consumption monopolies and fiscal monopolies are to be 
distinguished the one from the other only by the object which 
the government has in view in establishing them. If the govern- 
ment manages for itself or grants to another a monopoly of the 
liquor traffic with the object of regulating the consumption, the 
monopoly is a public consumption monopoly. If, on the other 
hand, the chief object is not regulation, but revenue for the 
government, the monopoly is a fiscal one. Often the two objects 
are blended. The production of salt has at one time or another 
been a fiscal monopoly in many different countries. The sale 
of tobacco is a fiscal monopoly in France. In recent years 
Japan has established a number of fiscal monopolies. 

The old monopolies established by special grant of the sovereign 
were in some cases fiscal monopolies, a heavy tax or royalty being 
paid by the monopolist. In other cases, however, they were 
based merely on public favoritism. A monopoly in one country, 
protected by a high tariff from the competition of producers in 
other countries, is rightly said to be based, so far as all or part 
of its monopoly power is concerned, on public favoritism. Mo- 
nopolies based on private favoritism derive their monopoly power 
from special advantages granted them by other monopolies, 
especially natural monopolies. Railroad rebates have been in 
the past a fruitful source of monopoly. 

Natural Monopolies. — ■ These depend for their existence on 
natural forces as distinguished from social arrangements. They 
grow up independently of man's will and desire and sometimes 
even in direct opposition to it. The words we have used to 
designate the first two classes of natural monopolies are self- 
explanatory. Natural mineral waters and certain wines made 
from grapes that are grown only in restricted areas are often 
good examples of monopolies derived from special limitations 
in the supply of raw materials. 

The Kimberley mines, of South Africa, virtually controlling 
the amount of annual additions the world's stock of diamonds, 
constitute a monopoly of this class. The limited area in which 
anthracite coal is produced in the United States is an important 
contributing cause of the monopolistic control of that industry. 



198 OUTLINES OF ECONOMICS 

Monopolies based on secrecy are no longer of great importance, 
although the use of secret processes remains in some instances 
a source of monopoly. 

By far the most important of all monopolies are natural monop- 
olies of the third class, arising from peculiar properties inherent 
in the business. Among such monopolies are roads and streets, 
canals, docks, bridges and ferries, waterways, harbors, light- 
houses, railways, telegraphs, the post office, electric lighting, 
waterworks, gas works, and street railways of all kinds. What 
are the properties inherent in such businesses that make them 
naturally monopolistic ? In some instances it will be found that 
the possession of peculiarly favorable spots or lines of land may 
give advantages important enough to create monopoly. This 
may be true, for example, of harbors, docks, street railways, 
rights of way through mountain passes or along narrow river 
valleys, and railway terminals in large cities. Often these 
are things which cannot be duplicated at all or can be dupli- 
cated only at a practically prohibitive expense. Monopolies 
created by the presence of such conditions are similar to natural 
monopolies of the first class. 

Natural monopolies of this third class are, however, more 
often rooted in conditions that make competition self -destructive. 
These conditions are three in number, and the presence of all of 
them is generally necessary to create monopoly: (i) The com- 
modity or service rendered must be of such a nature that a small 
difference in price will lead buyers to purchase from one pro- 
ducer rather than from another. (2) The business must be of 
such a nature as to make the creation of a large number of com- 
petitive plants impossible. Either because the business is one 
in which special advantages attach to large-scale production or 
because there are actual physical difficulties in the way of the 
multiplication of competing plants, there must be fairly definite 
limits to the possible increase of the number of plants among 
which the business might be divided. (3) The proportion of 
fixed to variable expenses of production must be high. 

These conditions, the reader will note, are conspicuously 
present in the operation of railways and of the so-called local 



MONOPOLY 199 

public utilities, as well as in other industries in which natural 
monopoly prevails. The principal reason why competition 
cannot be maintained in this field is that under the conditions we 
have listed competition Jails to fix a normal price remunerative 
enough to attract the recurrently necessary fresh investments 
of capital. Competition succeeds when either, first, the ex- 
penses of production are largely variable expenses, or, second, 
the total output of the industry comes from a large number of 
competing business units, some successful, others, very likely, 
operating on the narrowest possible margin of profits. When 
either of these two conditions is present in an industry, the 
aggregate amount of the ovitput will be delicately sensitive 
to changes in market price. If the price rises, the output will 
be increased ; if it falls, the total output, and with it the total 
expenses of production, will be diminished. In either event 
the change in price will be checked, and through this process, 
market prices will, in the long run, be kept just about high 
enough to induce the industry to maintain an output of whatever 
size may be justified by the demand for it. That is, the forces 
which fix a normal price will operate effectively. 

But if there are, at the most, only relatively few competing 
establishments in an industry, if fixed expenses are relatively 
large as compared with variable expenses, and if the market for 
the commodity or service produced is quick to take advantage 
of price cutting on the part of one or more of the establishments, 
it will be difficult to maintain competitive conditions. What 
would happen if one of the railways running between Chicago 
and New York should reduce its freight rates? First, it would 
immediately get a large share of the traffic. Second, the other 
railways would be forced to lower their rates, so that if the first 
railway desired to retain its increased traffic it would be forced 
to cut rates again. Third, it is clear that there is no stopping 
point in this process of competitive rate cutting, so long as the 
rates suffice to cover variable expenses. Fourth, since fixed 
expenses must, however, be paid, the competing railroads have 
to choose between (a) ultimate bankruptcy, and (6) the main- 
tenance of rates at a level fixed by joint agreement. This second 



200 OUTLINES OF ECONOMICS 

alternative means unity of action, or monopoly. Where com- 
petition is thus self-destructive, monopoly is inevitable. The 
operation of this principle has been exemplified many times in 
the history of American railways. A new " competing" rail- 
road has been built, it has cut rates to attract a share of the 
traffic ; a rate war has ensued ; and the end has always been mo- 
noply in the form of a combination or rate agreement. A simi- 
lar situation is found in the case of local public service companies. 
Twenty or thirty years ago many of our cities adopted the mis- 
taken policy of trying to force competition into this naturally 
competitive field. But very often it was found that the mere 
threat of competition was sufficient to bring about combination 
and monopoly. 

It is believed by some that the advantages of large-scale production 
increase so long as the size of the business establishment increases. If 
this were true, it would give production on the largest possible scale advan- 
tages so great that monopoly would result in all parts of the industrial field. 
Some socialists believe that this movement is so strong that it must result 
in the final disappearance of competition and the triumph of monopoly 
everywhere. Certain other students of the problem think that it is only in 
certain industries that the economies of large-scale production are sufficient 
to lead to monopoly. But in such fields, they hold, "capitalistic monop- 
olies" are sure to appear. 

It should be remembered, however, that the very large business establish- 
ment has disadvantages as well as advantages ; and it seems probable that 
beyond a certain point the disadvantages of a further increase in size grow 
more rapidly than the advantages. In most industries the point of maxi- 
mum efficiency is reached long before the point of monopoly is reached. 
It is difficult, and perhaps impossible, to find a single instance of successful 
monopoly in which one or more of the definite and specific sources of 
monopoly, mentioned in the foregoing classification, are not to be found. 
Our conclusion, then, may be stated as follows : There is a great and grow- 
ing field of industry in which competition is not natural or permanently 
possible ; there is another field within which monopoly does not exist, and 
in which it cannot exist except in the form of social (or artificial) monopoHes. 

Monopoly Price. — The chief peculiarity of monopoly price 
is found in the power of the monopolist over supply. This is, 
what gives the monopolist the ability to secure surplus profits. 
In competitive industry the supply is not within the control of a 



MONOPOLY - 20 1 

single producer, and, as a result, prices tend to be controlled or 
limited by the expenses of production. The competitive pro- 
ducer cannot increase his profits by limiting the supply, and it 
is on this account that the law regards competition as one of the 
main pillars of our present social order. 

The monopolist will normally endeavor to fix his output at 
such a point that, given the existing state of demand, he will 
secure the highest possible net returns. On the one hand he has 
to face the fact that although he can increase his gross receipts 
up to a certain point, by increasing his output, yet the increase 
in gross receipts will not be proportionate to the increase in out- 
put, for the simple reason that the increased output will not find 
buyers except at a lower price per unit. On the other hand an 
increase in his output will always increase his aggregate expenses 
of production, although here again the increase (in expense) 
may not be proportionate to the increase in output. In par- 
ticular there are likely to be some permanently fixed expenses 
which will be the same for a small output as a large one, and there 
may be other expenses which will not increase Unless the output 
should be made much larger than would be profitable. In fact, 
it may often happen that the fact that a large output would make 
it necessary to increase certain expenses which would otherwise 
be fixed (such as the cost of the plant) may lead the monopolist 
to choose to produce a relatively small quantity of goods. The 
following table shows in parallel columns the number of sales of a 
monopolized good at different prices, the total resultant receipts, 
the variable expenses, the fixed expenses, the total expenses, and, 
finally, the net revenue or monopoly profit. For the sake of 
simplicity it is assumed that all of the fixed expenses are perma- 
nently constant, at least for such possible increase of output as 
the monopolist cares to consider. 

Study of the table will show that, in the case assumed here, 
the monopoly price will stand at six cents. It would be possible 
for the monopolist to produce 5,500,000 units, for this would give 
him a net profit of $5000. But since he can control the supply, 
he will limit his output to 2,500,000 units, giving him the maxi- 
mum net return, $25,000. 



202 



OUTLINES OF ECONOMICS 



Price 

PER Unit 


Number 
Sales 


Total 

Earnings 


Variable 

Expenses 
PER Unit 


Total 
Variable 
Expenses 


Fixed 

Expenses 


Total 
Expenses 


Net 
Renenue 


$.IO 


600,000 


$ 60,000 


$.03 


f 18,000 


$50,000 


$ 68,000 


-$8,000 


.09 


800,000 


72,000 


•03 


24,000 


50,000 


74,000 


— 2,000 


.08 


1,200,000 


96,000 


■03 


36,000 


50,000 


86,000 


+ 10,000 


.07 


1 ,800,000 


126,000 


■03 


54.000 


50,000 


104,000 


+ 22,000 


.06 


2,500,000 


150,000 


■03 


75,000 


50,000 


125,000 


+ 25,000 


•OS 


3,500,000 


175,000 


•03 


105,000 


50,000 


155,000 


+ 20,000 


.04 


5,500,000 


220,000 


•03 


165,000 


50,000 


215,000 


+ 5. 000 



But the case assumed here is in many ways far simpler than 
the cases presented by real life. The monopolist may not be 
able easily to hit upon just the price that will yield maximum 
net profits. He may, by experimenting a little, approach more 
closely to it, but at best he can hardly hope to reach more than 
an approximate maximum. Or it may be that the monopoly 
is one in which the price is fixed by custom or convenience (as 
is in some measure true of street railway transportation), so that 
the monopolist can vary only the quality of the commodity or 
service he sells at the established price. Moreover, it should be 
noted that the price most profitable for the present may not 
prove the most profitable price in the long run. The monopolist 
may choose to forego some of his possible profits this year in 
order to extend the field of demand for his product and to lay 
the foundation of a long-continuing period of profitable produc- 
tion. Furthermore, in view of the possibility of the public reg- 
ulation or public ownership of his business, he may deem it ex- 
pedient not to arouse public hostility, and so may decide to sell 
at a price lower than what would, for the time being, be the most 
profitable price. 

The Effect of a Tax. — Our numerical illustration may be 
made to convey a lesson regarding the influence of taxation upon 
monopolies and monopoly price. Fixed expenses have no in- 
fluence in determining the price. If, therefore, a fixed tax, 
say of $5000 a year, were to be laid upon this monopoly, it would 
not result in an increase of price. A study of the table will show 



MONOPOLY 203 

that with such a tax the net revenue at price .08 would be $5000 ; 
at price .07, $17,000 ; at price .06, $20,000; at price .05, $15,000; 
at price .04, nothing. Thus price .06 will still be the point of 
maximum net revenue, and hence the monopoly price. On the 
other hand, a variable tax, for instance a tax of one cent per 
unit, would result in this case in raising the monopoly price. In 
our illustration, such a tax would make the net revenue at the 
price .08, — $2000; at the price .07, $4000; at the price .06, 
nothing; at the price .05, — $15,000. Thus, though the monop- 
oly would find its profits greatly curtailed by such a tax, con- 
sumers would be compelled to pay one cent more per unit for the 
monopoly product. The possible advantage which society 
might draw from the tax would therefore be wholly or in part 
offset by the increased cost of the commodity. We may conclude, 
therefore, that fixed taxes, or taxes on the net revenue of a mo- 
nopoly, cannot be shifted wholly or in part by a change in price ; 
while taxes laid in proportion to the amount of business, since 
they contribute an addition to the variable expenses, may be 
wholly or in part shifted by a change in price. 

Relation of Demand to Monopoly Price. — There are certain 
conditions on the side of demand which have a decisive influence 
in determining monopoly price. The most important of these 
is the degree of elasticity of the demand for the monopoly prod- 
uct. The more inelastic the demand jor the monopolized commodity 
or service, the higher will he the monopoly price which will yield 
the greatest net returns. If a commodity is a necessity of life, 
and is so habitually consumed that people cling with intensity 
to it, monopoly will, other things being equal, be more profitable 
than if the commodity were one which consumers thought they 
could easily dispense with. This helps to explain why salt and 
tobacco have been chosen as fit objects for public fiscal monopo- 
lies. The more adequate the substitutes for a commodity, the 
smaller will be the opportunity for surplus profits which a monop- 
oly of that commodity will give. Finally, the higher the general 
average of economic well-being, and the more readily money is 
generally expended, the higher will be the monopoly price 
which will yield the largest net returns. 



204 OUTLINES OF ECONOMICS 

Thus monopoly, without any effort of its own, shares in the in- 
creasing wealth of a country, and absorbs a considerable part of 
it. It is, for example, among other influences, the larger wealth 
per capita and the greater willingness to spend freely that makes 
monopoly more profitable in the United S.tates than in Germany 
or other European countries. 

Class Price. — Thus far we have assumed that the monopolist 
charges one uniform price and sets the price at the point which 
yields him the largest net returns. But it is obvious that his 
gains will be increased if he is able to vary his price. His gains 
would be highest if he could charge each individual that price 
which would yield the largest net returns, taking into account the 
number of sales and profits on each. A rich man might pay 
double the current rates for gas or electric light without dimin- 
ishing his consumption in the least. But in the case of any large 
modern business it is obviously impracticable to fix a price for 
each individual, even were there no legal difiiculties in the way, 
as there are in the case of the great monopolistic businesses such 
as gas and electric lighting and railway transportation. The 
next best thing for the monopolist is to divide his public into 
classes, and to charge to each class that price which will yield 
the largest net returns. In the table already given, we found 
that six cents was the monopoly price on the hypothesis of one 
uniform price, but obviously, if the eight-cent and seven-cent 
prices could be secured, and six cents reserved as a price for sales 
that could not be made at eight or seven cents, the profits would 
be still higher. ' This gives rise to what, in its broad, general 
terms, we call class price. The monopolist seeks in every pos- 
sible way to divide his community into classes and to secure 
from each the highest possible price. We observe a remarkable 
development of class price in the case of our railways ; and, unless 
legal obstacles are interposed, this development will doubtless 
go still farther. We have special trains with an extra charge. 
We have privately owned railway coaches ; our drawing-rooms 
and single seats in " parlor cars " ; our ordinary first-class 
tickets ; and our second-class tickets, the purchasers of which 
frequently ride in the " day coach " with the first-class passen- 



MONOPOLY 205 

gers. Then we have single tickets, fifty-trip family tickets, 
monthly commutation tickets, etc., with enormous variations 
in price. We may go farther and say that the American rail- 
way rate system of "charging what the traffic will bear " is a 
consummate example of monopoly prices. 

Nor need it be supposed that in all its ramifications class price 
is a bad thing. It is, when ignorance and need are exploited by 
a special high price ; frequently it works well when an attempt 
is made to reach a class of limited means with a very low price, 
as in the case of early and late workingmen's trains, etc. 

Monopoly price will vary with use also ; and this is one special 
subhead under class price, and may be designated as use price. 
The typical instance is that of two prices sometimes charged for 
gas : a higher when it is used for illuminating purposes ; a lower 
when it is used for fuel. 

Monopoly Price High Price. — It is often said, and frequently 
even in judicial decisions, that the monopolist can charge any 
price that he pleases. We have already seen that this is not 
the case. The law of monopoly price shows that the price, even 
in the case of monopoly, is determined by economic forces. It 
is conceivable that there may be cases in which monopoly price 
will exactly coincide with competitive price, although the prob- 
abilities would be against a frequent coincidence of this kind. 
There are also cases where monopoly price may be even lower 
than competitive price. If a monopolist should be able to effect 
great savings as compared with the expense of doing business 
under competition, it could happen, in theory, that the price 
which would yield the largest net returns would be a lower price 
than would be possible under competition. Probably, and in 
fact almost certainly, under a condition of competition, letters 
could not be carried as cheaply as they are. 

Generally there are strong reasons for the position that mo- 
nopoly price is high price. Monopoly is formed for the sake of 
gain. Gain may be secured in two ways by monopoly : first, 
through economies of production ; and it is alleged by trust pro- 
moters that these economies are a chief motive in their activity. 
There are some gains of this kind, but what their magnitude 



2o6 OUTLINES OF ECONOMICS 

may be in a particular case is highly uncertain. When we com- 
pare a monopolistic business with a competitive business organ- 
ized on such a scale as to secure the maximum of efficiency, the 
gains of competition in alertness and inventiveness, stimulated 
by rivalry, have recently been too little considered. 

The principal source of gain in monopoly is found in the ability 
to get a high price. In confirmation of the position that monop- 
oly price is high price, we may refer to history, the utterances of 
which seem to be clear and distinct. At any rate, there can be 
no doubt that, in the opinion of historians who have treated the 
subject, monopoly means high price. Hume, in his treatment of 
monopoly in his History of England, speaks of the price of 
monopolized articles as exorbitant, and cites the price of salt, 
the price of which had been raised by monopoly tenfold and 
even more. It is generally conceded that in most cases of a 
government monopoly of the production or sale of salt the price 
has been so extremely high as to be a real popular grievance ; 
and it is generally necessary to inflict severe penalties to pre- 
vent the people from securing the salt at a lower price from 
non-authorized sources. But of still greater significance are the 
results of the investigations of the Industrial Commission of 
the United States. It was there made evident that when 
monopoly appears in a form at all clear and well defined, the 
tendency is plain to increase the margin between the prices of 
finished products and raw materials.^ 

The courts of the world have made it clear in their judicial ut- 
terances that they regard monopoly price as high price ; and, as 
their opinions are based upon cases actually brought before them, 
we cannot do otherwise than attach great importance to their 
view. 

Wherever commissions have been formed with power to regu- 
late monopoly price, and these commissions have been comprised 
of independent and strong men, there has been a marked tend- 
ency to reduce monopoly price; because unregulated monop- 

1 See report by Professor J. W. Jenks on "Industrial Combinations and Prices," 
Report of the Industrial Commission, Vol. i, pp. 39-57 ; and also the same author's 
work, The Trust Problem, Chap. viii. 



MONOPOLY 207 

oly price has very often been found to be excessive and unjust. 
The opinions of the Railroad Rate Commission of Wisconsin 
afford many illustrations. This Commission has authorized a 
higher price in a few cases, but generally has been forced to lower 
prices, although in a notable case of passenger rates it did not 
go so far as the legislature subsequently did. The same state- 
ment holds true in large measure of the decisions of other state 
public utility commissions and of the Interstate Commerce 
Commission. 

Monopolies and the Distribution of Wealth. — We have not 
the precise statistical data which will enable us to state the exact 
influence of monopoly upon the distribution of wealth. We have, 
however, sufficient data to warrant the opinion that the high 
monopoly prices and the gains resulting from the exclusive posi- 
tion of the monopolist give us a large privileged class in countries 
of modern civilization, and especially in the United States. Even 
when the increment of price is comparatively small, it has large 
significance in the case of the sale of a vast number of units of 
services or commodities. The difference between a four-cent 
street-car fare and a five-cent street-car fare may not appear to 
be great, but it is a difference of 25 per cent and leads to an 
enormous difference in earnings. 

All the many investigations that have been made recently in 
various lines of business (especially in railways, the beef industry, 
the steel industry, coal mining, etc.) point to monopoly as a 
prime cause of the so-called swollen fortunes of this country. 
In this and other countries some histories of families distin- 
guished for wealth have been written, and probably few if any 
cases could be found in which some monopoly element had not 
entered. Various lists of rich men have been published, among 
them one published by the New York Sun in 1855, and one 
published by the New York Tribune in 1892. These lists can- 
not by any means be presumed to be accurate, and yet they do 
afford very considerable evidence of the sources of large for- 
tunes, and point to monopoly as a prime source of the enor- 
mous fortunes of today. This is a subject which in itself would 
require a larger book than the present one for adequate treat- 



2o8 OUTLINES OF ECONOMICS 

ment. The student should attempt by observation and study 
to carry forward the lines of investigation and thought here 
suggested. 

Public Policy with Respect to Monopolies. — As many mo- 
nopolies have come as a result of underlying laws of industrial 
evolution, they cannot all be abolished. Experience, and the 
analysis of industries like railways, gas works, etc., falling under 
the head of " public utilities," so called, should be conclusive. 
We must have monopoly in these cases, and the only question 
we are concerned with is, " What kind of monopolies shall we 
have ? ' ' We must admit that unregulated monopolies in private 
hands have always been odious and are opposed to the principles 
of the laws of civilized nations. They are opposed to that 
endeavor to secure equality of opportunity which is fundaihental 
in modern democracy and which manifests itself as a red thread 
running through American history. Even George Washington, 
generally looked upon- as calm and self-contained, denounced 
monopolizers and wished they might be " hunted down as pests 
of society " and " hanged on a gallows five times higher than the 
one prepared for Haman." ^ It is not so much high price that 
disturbs the modern man as it is inequality of opportunity ; and 
this general sentiment has been very clearly and forcibly ex- 
pressed in court decisions. In the field in which monopoly is 
natural and inevitable, therefore, we cannot permit unregulated 
special privilege, and to this end we must choose between pub- 
lic monopoly — government ownership — and public control of 
monopolies privately owned and operated. This opens up so 
vast a subject for discussion that we cannot enter into it here. 
It should be noted, however, that the considerations which must 
govern our choice differ for different types of natural monopolies. 
Municipal waterworks and the federal post office are in most 
respects efficiently and successfully managed. But in the case 
of many other natural monopolies the problems of management 
are more complex and difi&cult in many ways. Just now the 
method of public control rather than of public ownership is be- 
ginning to be given a thorough test. Our policy in the future 
1 C. J. Bullock, Essays on the Monetary 'History of the United States, p. 67. 



MONOPOLY 209 

will undoubtedly be determined in large measure by the results 
of that test. Public control, to secure equality of opportunity, 
must so regulate monopolies and limit price that the gains will 
be no higher than those produced by equally wise investments 
and equally wise and prudent management in the field of com- 
petition.^ Sometimes it is stated that owners of railways and 
other monopolistic enterprises should have a competitive return 
upon all the money that they have invested. This would give 
them a position of special privilege, inasmuch as in the competi- 
tive field a great deal of money is lost. It is only wise invest- 
ment and careful management in the field of competition that 
can secure returns equal or superior to the current rates of in- 
terest. Imprudently invested capital is lost in the field of com- 
petition ; and when it is imprudently and unwisely invested in 
the field of monopoly, it cannot justly claim any return. 

When we turn to the field of social monopolies we find that the 
problems of public control are simpler, but more diverse. These 
monopolies exist only by the approval or tolerance of society, 
and each particular one can be judged on its own merits. The 
problem of social monopolies, therefore, resolves itself into such 
problems as those of the economic effects of the patent system, 
the best way of controlling the consumption of liquors and 
other harmful commodities, and the most expedient means of 
raising public revenues. With respect to one class of social 

1 This does not mean that in the case of old enterprises price must always be so 
reduced that the gains shall yield a competitive return only on the physical value 
of a plant. The principle of vested rights or interests has to be given a certain 
role. These have often been created by society rather than by private persons, and 
faith must be kept. In the case of railways and the telegraph, the American nation 
and states have deliberately encouraged a wasteful policy of competition which 
is in large measure responsible for high capitalization. It would not be right 
to place upon holders of these properties all the burdens of a mistaken public poHcy 
in the past. What is needed is to declare a public policy for the future and to base 
returns for the future upon future actual investments in the case of public utilities. 
In any case, our federal and state governments are acting wisely in insisting upon 
physical valuations of railways, gas works, and other similar monopolies as a help 
in determining fair prices for present and future. Now and here we can do no more 
than to throw out these suggestions in regard to a pressing present problem of great 
magnitude. A further discussion of some aspects of the problem will be found in 
Chap. XXVII (Transportation). 
P 



2IO OUTLINES OF ECONOMICS 

monopolies society has reached a very definite conclusion : There 
must be no needless extension of the field of monopoly through 
either public or private favoritism. The possibility of obtaining 
monopol}/ through special privilege is clearly inconsistent with 
the maintenance of equal opportunity in the industrial field. 

The problem of the public control of monopoly is sometimes 
confused with the " trust problem " — the problem of the public 
control of large industrial combination. But the trust problem 
is only in part a problem of monopoly. It will be discussed in 
the following chapter. 

QUESTIONS AND EXERCISES 

1. Has bigness anything to do with monopoly ? Do you know any small 
business which is a monopoly? Do you know any very large business which 
is keenly competitive? Contrast a state of competition with a state of 
monopoly. 

2. Define monopoly and discuss each point in the definition. 

3. Contrast land ownership with monopoly. 

4. Explain the importance of classification of monopolies, and especially 
of distinguishing between private and public monopolies, and social and 
natural monopolies. 

5. State the main clashes of monopolies, and give the divisions and sub- 
divisions in each class. 

6. A public tobacco monopoly exists in France and produces large rev- 
enues. The business is generally said to be well managed. Do you see 
any benefits that would accrue from the establishment of such a monopoly in 
the United States ? any evil effects ? 

7. Define monopoly price and show how it is determined. 

8. What does class price mean? Explain use price. 

9. Why do we think of monopoly price as high price ? Do you know any 
monopoly price which is a low price? What do you mean by high price? 
by low price ? 

10. What relation has monopoly to large fortunes? to small fortunes? 
What, if any, to poverty? 

11. What is the best public policy with respect to monopolies? 

REFERENCES 

Brown, W. J. The Prevention and Control of Monopolies. 

Ely, R. T. Monopolies and Trusts, Chaps, i-iv. 

HoBSON, J. A. Evolution of Modern Capitalism, revised ed.. Chap. ix. 



MONOPOLY 211 

Levy, Hermann. Monopoly and Competition. 

Marshall, Alfred. Principles of Economics, 6th ed., Book v, Chap. xiv. 

PiGOU, A. C. Wealth and Welfare, Chaps, ix-xiii. 

Price, W. H. The English Patents of Monopoly. 

Taussig, F. W. Principles of Economics, Vol. i, Chap. xv. 

United States Industrial Commission. Report, Vols, i and ii. 



CHAPTER XIII 
BUSINESS ORGANIZATION 

The Meaning of "Business." — The dominance of "busi- 
ness " in our present social economy is so familiar and common- 
place a thing that we are apt to forget its real significance. 
" Business " means profit seeking. It does not cover so broad 
a field as does " production," nor is it quite the same thing as 
" production for the market." Business is acquisitive rather 
than productive, and while acquisition usually involves produc- 
tion, this is not invariably the case. Business operations con- 
sist, fundamentally, in buying or hiring things and in selling 
them or using them for the purpose of gaining a profit. Among 
the things thus bought or hired are land, labor, capital goods, 
and business privileges or advantages, such as franchises, patents, 
copyrights, and " good-will." The economic world, in its busi- 
ness aspect, is a world of buying and selling rather than of making 
and using things ; it is a world in which prices, expenses, debts 
and credits, and contractual relations are the dominating things 
rather than the technical processes of production or the ultimate 
costs of production as measured in human effort and sacrifice. 
Commerce and manufactures have each in turn been brought 
under the dominion of business enterprise ; business methods and 
motives are also of the first importance in agriculture, although 
in this last field production for home use continues hand in hand 
with production for profit. 

The Nature of Business Units. — The business world is made 
up of profit-seeking units, — entrepreneurial units. We are apt 
to think of business units as composed of individual men or 
groups of men. In an ultimate sense this is not incorrect, but 
for present purposes we may more profitably view business units 



BUSINESS ORGANIZATION 



213 



as merely the centers ox foci of the contractual and other rela- 
tions that bind the business world together. These relations are 
recorded and stated more or less fully in the accounts of each 
business unit; ultimately, however, they are matters of legal 
fact, and, as we shall see, the legal aspect and the accounting 
aspect of these relations are not always identical. 

The Business Unit in Accounting. — The simplest general 
way in which a business unit can be described by its accounts 
is by means of the balance sheet, which is the statement of the 
assets or resources and the liabilities or obligations of the busi- 
ness unit as they exist at a particular time. The following is a 
simplified form of balance sheet for a small manufacturing 
establishment : 



Assets 



Liabilities 



Land and buildings . . : 

Machinery and fixtures 

Raw materials, goods in 

process, and finished 

goods on hand . . . 

Accounts receivable . . 

Cash on hand and in banks 

Total assets .... 



1190,000 
50,000 



40,000 

28,000 

7,000 



J 1 5,000 



Original capital invested 
Income reinvested . . 
Accounts payable . . 
Profits 



Total liabilities 



f200,000 
70,000 
20,000 
25,000 



515,000 



The itemized assets explain themselves, but the meaning of 
the various liabilities may not be so clear. In this statement all 
the items of the liabilities except " accounts payable " are liabil- 
ities of the business unit, conceived as a separate thing, to its 
owner or owners, — the amount which would be left if the 
business were sold as a whole at a price just equal to the total 
estimated value of the assets minus the actual outstanding obli- 
gations (the accounts payable).^ It will be noted that the item 
called " profits " is the variable by which the account is bal- 
anced. 



1 The form of balance sheet given in the text is a simple adaptation of the kind 
of balance sheet used in the published statements of corporation accounting. But 
if the individual proprietor of a small business keeps an accurate ledger account 
with himself, the result is the same so far as the independence of the business as an 
accounting unit is concerned. 



214 OUTLINES OF ECONOMICS 

On such a showing as this the owners might decide to take $5000 out of 
the business as dividends, or personal profits, as the case may be. This 
would reduce the "cash" to $2000 and correspondingly reduce "profits." 
They might decide, also, permanently to retain $10,000 of their earnings 
in the business. "Profits" would then be reduced to Sifi^ooo, and the 
"income reinvested" would be increased to $80,000. In the case of cor- 
porations the "original investment" item is called "capital" and repre- 
sents the par or nominal value of the corporation's stocks and bonds, whether 
or not the corporation has received this amount in return for them. Sur- 
plus profits in such cases can be easily converted into "capital" by means 
of "stock dividends." 

The business unit is pictured in the balance sheet as the ovi^ner 
of various kinds of valuable property and of valuable claims 
against those indebted to it. But on the other hand, as the 
balance sheet also shows, there are rights or claims of equal 
amount against the business unit on the part of its ov^^n creditors 
and proprietors. The liabilities side of the balance sheet shows 
how the ultimate rights or equities in the property and credits 
shown as assets are distributed among creditors and proprietors. 
The business unit, as a thing apart from its proprietors, has 
only an imaginary existence. But it is convenient to think 
of it as having valuable rights or assets of its own, and to think 
of the claims against these rights as being distributed in the form 
of obligations or liabilities. This explains the statement that 
business units are the centers or foci of business relations. 

In its legal aspect, however, the business does not always have 
so distinct a unity of its own. This varies with the form of 
business organization, of which there are three important 
types : the individual entrepreneur, the partnership, and the 
corporation. 

The Individual Entrepreneur. — Any individual may set him- 
self up as a business man, an entrepreneur, without any legal 
formality other than the payment of the license fee which most 
states impose on some kinds of business undertakings, such as 
liquor dealing, and which some states, especially in the South, 
impose upon many kinds of undertakings. The individual en- 
trepreneur still dominates the field in agriculture, in small retail 
trade, and in local " shop industries." 



BUSINESS ORGANIZATION 215 

In the legal aspect the obligations of a business conducted by 
an individual entrepreneur are the personal obligations of the 
entrepreneur. All of his possessions — of whatever kind ^ — • are 
jeopardized by his business risks. If the entrepreneur conducts 
two distinct business undertakings, the assets of one may be 
seized, if necessary, to secure the liabilities of the other. The 
personal liability of the individual entrepreneur is accordingly 
said to be unlimited. The usefulness of this kind of business 
organization is limited, obviously, to small undertakings, where / 
the capital and credit of the individual man are adequate. ' 

Partnerships. — A " firm " or partnership represents a joint 
undertaking by individual entrepreneurs. Partnerships are 
most common in mercantile undertakings of moderate size, in 
small manufacturing establishments, and in the professions. 
This joining of interests makes larger undertakings possible, but 
relatively increases the personal liability of the individual mem- 
bers of the firm. For each member is personally liable for all of 
the obligations contracted by the firm, including those contracted 
in the ordinary course of business by any other one member of 
the firm.2 The partners may have a contract binding among 
themselves as to their respective contributions (of money or 
time), shares in profits, and liabilities. But a member released 
from personal liability by an agreement of this kind is still liable 
for all obligations incurred by the firm. The agreement only 
gives a basis for instituting legal proceedings to recover the 
amount of his personal losses from the other members of the firm. 

Aside from (i) the excessive personal liability involved, the 
partnership is open to objection from the business man's point 

iThe "exemption laws" of some states constitute an exception which does 
not affect the principle involved. 

2 This refers to the status of the ordinary partnership under common law. The 
statutes of most of the states provide for a special form of limited partnership, in 
which one or more of the partners are special partners, who are not personally 
liable, save for their investment in the business, and who are allowed to take no 
active part in the management of the business. In a few states there is a special 
form called a limited partnership association, in which the liabihty of all the partners 
is limited. These are practically joint-stock companies with non-transferable 
shares. The partnership in commendam, which still exists in Louisiana as a heritage 
of the civil law, is essentially like the statutory limited partnerships of other states. 



2l6 OUTLINES OF ECONOMICS 

of view, because : (2) It is impossible for a partner to retire from 
a firm without dissolving the partnership and, possibly, break- 
ing up the business. The death or insolvency of any partner has 
the same effect. (3) A new member cannot enter the firm nor 
can a member transfer his interests to another person without 
the consent of all the members of a firm, — requirements which 
naturally follow from the nature of a partnership. (4) The 
partnership form of organization is not adapted to undertakings 
requiring large investments of capital and hence requiring the 
cooperation of a large number of persons. What advantages the 
partnership has come from the ease with which it can be organ- 
ized and dissolved, and from its elasticity, — that is, the ease 
with which the contractual relations among the partners, bind- 
ing as among themselves, can be altered to suit any contingencies 
that may arise. 

The Business Corporation. — The federal census of 1909 
showed that, although only about one fourth of the manufactur- 
ing undertakings included in that enumeration were organized 
as corporations, yet these produced nearly four fifths of the total 
manufacturing product (measured in money value). Most 
banks and insurance companies are corporations, while in the 
field of railway transportation corporations are in almost exclu- 
sive control. And a large and growing number of mercantile 
undertakings are organized as corporations. 

In the case of the corporation the legal view and the account- 
ing view of the business unit are practically identical. While 
the ordinary partnership is in law merely a group of individual 
entrepreneurs, the corporation is regarded, for some purposes, as 
a " person." To the incorporated business unit, — an abstract 
thing, as we have seen, — the law imputes some of the attributes 
of personality, — and of a personality distinct from that of the 
individual men who are the stockholders of the corporation.^ 

1 Several states authorize the organization of "joint-stock companies" which 
are Hke corporations in many particulars. In theory they are partnerships with 
transferable shares and (in some cases) with limited Uability. Joint-stock com- 
panies are also organized mider the common law in some states. In England and 
the English colonies the name "joint-stock company" is applied to a statutory 



BUSINESS ORGANIZATION 217 

Municipalities, universities, monasteries, guilds, etc., were commonly 
incorporated by royal charter long before business corporations of the 
modern kind arose, — for this did not occur until the rise of "capitalism" 
in the sixteenth and seventeenth centuries. The great trading and coloniz- 
ing companies, such as the British East India Company, the Virginia Com- 
pany, the Guinea Company, etc., were the prototypes of the modern business 
corporation. In connection with these trading companies the joint-stock 
principle, which had already been used in a few isolated instances of banking, 
was developed. This was the practice of issuing certificates to those who 
made contributions to the "joint stock" (or capital) of a company, which 
entitled the holder to a proportionate share in the profits accruing to the 
joint stock. The modern business corporation, like these early trading 
companies, is based essentially on the combination of the joint-stock prin- 
ciple with the legal recognition of the business unit as a distinct entity. 

At the beginning of the nineteenth century what few corporations there 
were in America were, for the most part, banks, insurance companies, or 
canal and turnpike companies. The introduction of railways in the third 
decade of the century greatly stimulated the organization of corporations, 
because these new undertakings required larger investments of capital than 
could be furnished by any individual or firm. State enterprise, it is true, 
promised at one time to be an important factor in canal and railway building, 
but such state undertakings were usually planned with the purpose of de- 
veloping natural resources, attracting immigration, and building up the 
trade of particular districts and particular cities rather than of getting money 
profits. Most of these state undertakings had succumbed by 1840, so that 
the field was left open for business enterprise. In the general expansion and 
reorganization of business that followed the Civil War the corporation form 
of organization began to be more generally used for all kinds of business 
undertakings. The growing importance of corporations in business life is 
partly an effect and partly a cause of the growing size of the business unit. 

The Corporation Charter. — The corporation is a creature of 
the state, its right to exist being dependent on a charter or on 
articles of incorporation, granted or approved by the state. In- 
corporation formerly necessitated a special act of the legislature 
in each case. This gave opportunity for favoritism and monop- 
oly and subjected corporations of all kinds to hostility and 
suspicion. Most corporations are now organized under general 
laws, whereby any group of men can secure a corporation 

limited-liability association, essentially like the American business corporation, 
while the word " corporation " is usually applied only to municipal corporations 
and certain long-established companies, created by special charters. 



2l8 OUTLINES OF ECONOMICS 

charter by complying with certain prescribed conditions. In 
fact, all but six states now have constitutional provisions 
against the granting of charters to business corporations by 
special act. 

It was formerly a common practice to grant corporation char- 
ters in perpetuity, but the decision of Chief Justice Marshall in 
the Dartmouth College case (1819), whereby the corporation 
charter was declared to constitute a binding contract between the 
state and the corporation, which could not be altered or amended 
by the state except with the consent of the corporation, has led to 
the general practice of limiting the life of corporations to terms 
of from twenty to one hundred years, fifty years being a common 
period. The corporation may, of course, secure a new charter 
at the expiration of the old, but the limited term gives the 
state the opportunity to change the requirements of the 
charter from time to time, or to refuse reincorporation alto- 
gether, as may seem most desirable. Most states, moreover, 
now specifically reserve the right to alter or amend the corpora- 
tion charter at pleasure. 

Corporation charters, or articles of incorporation, usually con- 
tain details relating to such matters as the purpose or purposes 
for which the corporation is formed, its principal place of busi- 
ness, the number of its directors, and the amount of its capitali- 
zation. 

Lack of Uniformity in State Laws. — Many difl&culties in the 
public control of corporations have arisen from the fact that 
while charters are granted by individual states, the activities of 
many business corporations extend over the boundaries of many 
states. Moreover, some states are much more lenient than 
others in such matters as the control of capitalization, require- 
ments as to publicity, limitations on the scope of activity of a 
single corporation, taxes and fees, etc. New Jersey has become 
known as the " home of corporations " despite the fact that some 
states have had even more lenient laws than New Jersey. New 
Jersey has been favored, however, on account of the proximity 
of New York City — the real home of most of the greater cor- 
porate interests of the country — as well as on account of its 



BUSINESS ORGANIZATION 219 

early start and the adaptability of its laws to great combinations 
of corporations.^ 

Other states, with stricter laws, could not prevent corporations 
organized under lax laws from doing business within their terri- 
tory so far as that business is interstate. So far, however, as a 
corporation organized under the laws of one state carries on any 
part of its business wholly within the borders of another state, 
the latter state has the right of refusing to recognize it as a cor- 
poration ; that is, the right to treat it as a mere partnership. In 
practice, however, one state freely recognizes the corporations of 
another state under the rule of " interstate comity." In fact, 
many corporations transact practically all of their business out- 
side the borders of the state which chartered them. The real 
standards, therefore, are the laxest standards, not the highest. 
More use on the part of American states of the power of exacting 
certain standards from " foreign corporations," as they are 
called, is much to be desired. 

Corporation Capital and Capitalization. — The business world 
uses the term " capital " in two ways. It speaks of the total 
permanent investments — the amount of money "tied up" in a 
business unit — as its capital. This is the better and more 
common usage. But it also speaks of the total selling value of 
the business unit as a whole as its capital. This last will depend 
not so much upon the amount of the investment as upon its 
profitableness. It is roughly measured by the " capitalized " 
earning capacity of the business, or by the market value of the 
corporation's stock and bonds. 

The capitalization of a corporation should not be confused with 
its capital. In a strictly legal sense its capitalization is the 
amount of its authorized capital stock. The capitalization cor- 
responds, in theory, to the amount of money actually invested 
in the business by the original stockholders. As a matter of 
fact, the full amount of the authorized capital is rarely paid in at 
the organization of a new corporation. The capitalization is 
apt to be, in practice, a somewhat arbitrary thing, — a nominal 

'In 19 1 3 the corporations laws of New Jersey were revised so that they offer 
fewer advantages to large corporations than they previously did. 



220 OUTLINES OF ECONOMICS 

money sum divided into units or shares, the relative holdings of 
different individuals being measured by the number of shares 
they own. 

Corporation stock is divided into two general classes, — pre- 
ferred stock and common stock, although many corporations issue 
only the latter. Preferred stock represents a prior claim on the 
earnings of the corporation. A corporation which has " 6 per 
cent preferred stock " outstanding can pay no dividends to its 
common stockholders until it has paid 6 per cent dividends on 
its preferred stock. Preferred stock may be cumulative (in which 
the prior claims to dividends accumulate from year to year, if 
unpaid) or non-cumulative. It may or may not have any claim 
on any part of the surplus profits remaining after a stated rate 
of dividend has been paid on the common stock. 

In the popular use of the word the capitalization of a corpora- 
tion includes also its funded debt. The funded debt is represented 
by bonds, which are interest-bearing promises to pay certain sums 
of money at definite times in the future. There are many differ- 
ent kinds of bonds, but three principal classes are : (i) ordinary 
mortgage bonds, (2) collateral trust mortgage bonds, (3) income 
and debenture bonds. The first class is based on a mortgage 
of all or of a specific part of the real property of a corporation. 
Collateral trust mortgage bonds are secured by the pledge of 
securities issued by other corporations, but owned by the corpo- 
ration issuing the bonds. They have been much used in financ- 
ing railway consolidations. Income and debenture bonds are 
usually secured only by the earning capacity of the business. 
Industrial corporations make less use of bonds than do railways, 
and confine themselves usually to the mortgage bond type, — 
of which, however, there are many subordinate varieties. In 
the case of many corporations the mortgage security behind an 
issue of bonds is in itself not of great importance, for the property 
mortgaged is apt to be worthless except as an integral part of a 
unified business establishment. The mere power of foreclosure, 
however, gives mortgage bondholders a position of strength 
in the reorganization of insolvent corporations. 

Bonds are sometimes said to represent " creditor interests," 



BUSINESS ORGx\NIZATION 221 

and stock " proprietorship interests." This statement is sug- 
gestive and is not inaccurate. In a more general sense, however, 
stock and bonds are merely different kinds of equities in a busi- 
ness unit, — conveying the right to receive income, to share in 
the distribution of the assets in case of insolvency, and to have a 
voice in the management. Stockholders alone participate in 
the management of the corporation, although bondholders 
are often able to dictate policies when the affairs of a corporation 
are in a precarious condition. Bonds differ from stock in being 
terminable at a definite period of time in the future. In practice, 
however, the bonds of great corporations are usually replaced 
by new issues as rapidly as they mature. 

Overcapitalization. — Much has been said about the over- 
capitalization of corporations, — " stock watering," as it is 
called. Only a few states require that all the nominal capitaliza- 
tion of corporations organized under their laws shall represent 
capital actually invested. In most states, moreover, it is not 
difficult for a corporation to increase its capitalization from 
time to time so as to secure funds from the sale of securities, 
or (as in the case of stock dividends) in order to afford a basis 
for the distribution of surplus profits without employing an 
excessively high dividend rate. 

On the one hand it is urged that capitalization is a nominal 
thing, that it is immaterial whether a corporation pays 12 per 
cent dividends on $1,000,000 of capital stock or 6 per cent 
dividends on $2,000,000 of capital stock. On the other hand it 
is said that capitalization should not be a merely nominal thing, 
but that it should correspond to the actual amount of the invest- 
ment; that, without regard to the amount of capitalization, 
regularly recurring dividends of 12 per cent suggest excessive 
profits in a way that 6 per cent dividends do not. 

The argument in favor of a closer correspondence between 
capitalization and real investment is especially strong in the 
case of railways and other transportation corporations with 
quasi-public functions, municipal public service corporations, 
and corporations enjoying natural monopolies of all kinds. For 
there is a growing feeling that such corporations are in a peculiar 



222 OUTLINES OF ECONOMICS 

sense social trustees, to whom have been committed certain 
public economic functions that might very properly be per- 
formed by the State, if that course were deemed the more advan- , 
tageous. That such corporations should be restricted to the 
payment of a reasonable dividend on reasonable capitalization 
would seem scarcely to be open to question.^ Yet excessive 
profits are what make excessive dividends possible, and whether 
profits are excessive or not can be determined in most cases 
without reference to capitalization by the compulsory use of 
adequate accounting methods. Even where accounting methods 
used in the past have been inadequate, the amount of the in- 
vestment entitled to a return can usually be determined with 
rough accuracy by means of a "valuation" or appraisal of a 
company's properties, coupled with an examination of the prin- 
cipal facts of its financial history. There is a growing use of 
this method on the part of both federal and state governments. 

There is a prevalent but entirely mistaken belief that over- 
capitalization is often the cause of exorbitant charges. It is 
thought that the desire to pay dividends on an inflated capitali- 
zation leads corporations to exact a higher return for their prod- 
ucts or their services than they otherwise would. But it can 
easily be seen that such cannot often be the case. For whether 
its capitalization be high or low the corporation will desire to 
fix its charges at the level which will yield the greatest possible 
profits. The magnitude of the corporation's capitalization will 
have no bearing upon the determination of the most profitable 
level of charges. The charges which would be most profitable 
under a low capitalization will also be the most profitable under 
a high capitalization. 

A weightier indictment of overcapitalization is that it has 
opened the door to a number of reprehensible practices in cor- 
poration promotion and management. Where there is no defi- 
nite correspondence between capitalization and investment it 
is difficult to make sure that some persons will not be able to 
acquire the securities of a given corporation on much easier 

1 It is better to curtail excessive profits by public control of rates, prices, and 
services than by arbitrarily limiting the dividend rate. 



BUSINESS ORGANIZATION 223 

terms than others. Overcapitalization always makes available, 
for example, what may be termed a surplus of stock, and this 
surplus, instead of being distributed equally among the differ- 
ent stockholders, may be used in a disproportionate and extrava- 
gant payment to the promoter (or organizer) of the corporation, 
or the bankers who have assisted in marketing its securities. 
Or a group of men in control of a corporation may reap an unfair 
advantage at the expense of other security holders by turning 
over to the corporation properties of which they themselves are 
the owners in return for an exorbitant amount of the corpora- 
tion's securities. Operations of this kind have only too fre- 
quently attended the organization of great industrial combina- 
tions in this country. American railway history, also, is full of 
examples of extravagant sums paid by operating companies to 
" construction companies " which had been organized for the 
purpose of building the roads and selling them to the operating 
companies. These payments were usually made in bonds or 
stock, and burdened the operating company with either a heavy 
load of fixed charges or an inflated amount of capital stock. In 
fact, the time is not long past when it was frequently said of 
representative American railroads that the whole amount of 
the actual investment in their properties was represented by 
their bonded debt, while their stock issues represented nothing 
but prospective surplus earnings. In the promotion of industrial 
combinations it was common practice to issue enough preferred 
stock to cover the actual expense of acquiring the various proper- 
ties brought into the consolidation and to issue in addition a 
large amount of common stock representing nothing except 
whatever increase in earning power might result from combina- 
tion. The common stock, at whatever price it could be sold, 
represented, in fact, the profits of promotion ; and these usually 
went to promotors and other " insiders." In both the railway 
and industrial field, however, conditions are much improved. 
In many cases large additional investments have been made out 
of earnings without a corresponding increase in capitalization; 
in certain other cases corporations have been reorganized, 
with reduced capitalization. But, nevertheless, there are recent 



224 OUTLINES OF ECONOMICS 

instances of unfair and even fraudulent use of excessive capitali- 
zation as a means of securing special profits for those in control 
of a corporation's policies.^ 

The situation is clearly one that needs mending. Two very 
different methods of regulation have been proposed. The first 
of these two methods involves the definite limitation of a cor- 
poration's capitalization to an amount corresponding to the 
sum of money actually received by the corporation and invested 
in its business. If securities are issued in exchange for property 
turned over to the corporation or for services rendered it, a full 
account must be rendered of all of the circumstances attending 
such transactions, and an official appraisal of their value may 
even be required. Such, in general, have been since 1884 the 
conditions under which joint-stock companies in Germany issue 
their shares, and it does not appear that these requirements have 
hindered the organization or growth of such companies in that 
country. 

Under the second method of regulation, corporations are left 
free to issue their securities in such quantities as they deem best, 
it being required merely that publicity shall be given to the 
prices at which the securities are sold, to the price placed upon 
any property or services paid for in securities, and to the disposi- 
tion made of all money obtained by the issue of securities. This 
kind of regulation is adopted, in principle, in the British Com- 
panies Act, but the mechanism provided to enforce it is not very 
effective. At best, however, even the most thoroughgoing 
publicity respecting the conditions under which securities are 
issued cannot be a wholly adequate safeguard against the real 
evils of over-capitalization. Publicity might tend to curb ex- 
travagant allowances for personal services, but it would not al- 
ways prevent the overvaluation of large properties taken in 
exchange for securities. To think otherwise is to count too 
much upon the knowledge and alertness of the individual stock- 
holder. Certain American railroads have openly paid exorbi- 
tant prices for branch lines and other properties, without re- 

1 See the special reports of the Interstate Commerce Commission on the St. 
Louis and San Francisco and the New York, New Haven, and Hartford railroads. 



BUSINESS ORGANIZATION 225 

ceiving any protests, at the time, from stockholders and creditors 
injuriously affected by these transactions. 

We have done very little in the United States in the regulation 
of the capitalization, or the other conditions of promotion, of 
ordinary industrial corporations. Some states, however, now 
exercise a fairly rigid control over the new security issues of rail- 
ways and other public service corporations. This regulation, 
however, does not have as its primary motive the protection of 
minority stockholders. It is to be interpreted as part of a gen- 
eral attempt to limit the earnings of such corporations to a fair 
return upon a reasonable capitalization. 

It has been suggested ^ that in order to guard against the very prevalent 
misunderstanding of the real nature of corporation shares, the "dollar mark" 
should not appear on them, or, in other words, that they should have no "par 
value." They would then become, in form as in fact, merely certificates of 
the ownership of certain fractional equities in a corporation's business. 
There is much that is attractive about this proposal. If the issue of securi- 
ties is to be as unregulated as it has been in the past, it would be better to 
make it impossible for investors and the general public to attach any ficti- 
tious importance to the amount of a corporation's capitalization. But if 
we are to have the regulation of promotion and capitalization that we need, 
there would be nothing gained by the change suggested. And the "dollar 
mark" on stock certificates is convenient in many ways. 

Form of Capitalization. — A significant feature of recent de- 
velopment in corporation finance, is the multiplicity of types of 
corporate securities. It is no uncommon thing, for example, for 
the equities in a railway corporation (in addition to the floating 
debt, or accounts payable) to be divided among a dozen or 
twenty varieties of bonds and two or three varieties of stock. 
This multiplicity of securities is of advantage to the corporation 
in that it enables it to offer to investors and speculators a care- 
fully graded assortment of risks, and this makes the total selling 
value of a corporation's securities greater than it would other- 
wise be. This complex kind of capitalization has, however, some 
undesirable features. If the owners of a particular security — 
the common stockholders, perhaps — control the corporation, 

1 Most recently by the very able federal Railroad Securities Commission of igii. 
The state of New York now permits the issue ^ f corporate shares without par value. 
Q 



226 OUTLINES OF ECONOMICS 

they may desire to increase the value of their securities for specu- 
lative purposes by the payment of unearned dividends, — a pro- 
ceeding which would be opposed to the interests of the holders 
of all the other securities of the corporation. Or the holders of 
preferred stock may wish to put some of the earnings of the cor- 
poration back into improvements in its plant, so as to safeguard 
its future earning capacity, while the holders of common stock 
may prefer that all the earnings be paid out in dividends. More- 
over, in cases of insolvency and reorganization, it is a difficult 
matter to untangle and to adjust equitably the rights of the 
holders of the different kinds qf securities. 

In times of prosperity corporations often pay for extensions of 
their plants from the proceeds of bond sales, because it is esti- 
mated that the earning power of such extensions will more than 
suffice to pay the interest on the bonds and will afford a hand- 
some surplus for the stockholders. Corporations thus accumu- 
late in prosperous times an unwieldy load of fixed charges in the 
form of interest on bonds, — a fact which is apt to be a source 
of difficulty in less prosperous years. In periods of financial 
stringency these fixed charges are a common cause of insolvency, 
receiverships, and consequent reorganizations, from which the 
bondholders are apt to emerge as stockholders, and in which 
the stockholders are apt to lose their holdings. The legal restric- 
tion of the securities issued by any one corporation to one kind 
of stock and three or four varieties of bonds is both feasible and 
desirable. Nor should the bonded debt usually be allowed to 
exceed the amount of the paid-up capital stock. 

Corporation Management. — The management of business cor- 
porations is, as a rule, in the hands of boards of directors, elected 
by the stockholders from among their own number. The details 
of management are in the hands of officers, chosen usually by the 
directors. In principle this system achieves something like rep- 
resentative government of the affairs of the corporation. In 
practice, in the larger corporations, some of the directors are apt 
to be " dummy directors," — men exercising no real power or 
responsibility, made directors in order to complete the number 
prescribed in the charter, — or are the representatives of great 



BUSINESS ORGANIZATION . 227 

financial interests, and often of competing interests. Directors 
of this latter sort are not primarily concerned with the manage- 
ment of a corporation in the interests of its stockholders and 
bondholders. They are directors for the purpose of guarding 
special interests, and in many cases for the purpose of preventing 
competition from becoming anything more active than an armed 
peace. In some cases the real direction of a corporation's 
policies is in the hands of an " executive committee " or " finance 
committee " of three or more directors representing the person 
or persons in actual control of the corporation. 

The proper adjustment of the rights and' duties of the various 
members of a corporation is a matter of general public concern. 
This is partly because the shares in a corporation are freely trans- 
ferable. A new member cannot protect himself by making 
special contracts with the other members, but must accept the 
conditions fixed by the by-laws of the corporation and by the 
laws of the state which chartered it. Moreover, the ordinary 
shareholder in a large corporation has little opportunity to par- . 
ticipate in any way in the conduct of the affairs of the corpora- 
tion, even for the purpose of protecting his own interests. The 
general theory upon which the law of corporations is based is 
that the corporation is a democracy with a representative gov- 
ernment. That is, the directors are supposed to represent the 
interests of the stockholders. For many small local corpora- 
tions this theory undoubtedly corresponds fairly well with the 
facts. But large corporations, with hundreds or thousands of 
stockholders, living in different parts of the country, and even 
in different countries, cannot accurately be pictured as rep- 
resentative democracies. Outside of a group of holders of 
large blocks of stock, the stockholders, whether a minority 
or a scattered majority, are likely to be not only powerless but 
voiceless. It is difficult and probably undesirable to change 
this general situation. The growth of large corporations 
means necessarily the growth of widespread participation in 
large business undertakings. But the participators, whether 
stockholders or bondholders, are to be regarded as investors 
rather than active partners. What is needed in our corporation 



228 OUTLINES OF ECONOMICS 

statutes, therefore, is a frank recognition of this situation. In 
many cases directors cannot, in any real way, " represent " the 
stockholders. For this reason their responsibility as trustees 
for the stockholders should be emphasized in our laws.^ 

Advantages of the Corporation as a Form of Business Organ- 
ization. — From the point of view of the business man the cor- 
poration presents decided advantages over the partnership for 
all undertakings of considerable size. Some of its points of 
superiority are : (i) Stockholders usually have no personal lia- 
bility for the corporation's obligations except so far as the full 
par value of their stockholdings has not been paid up.^ (2) The 
relative permanence and stability of the corporation are of de- 
cided advantage, especially in undertakings requiring large in- 
vestments of capital in relatively fixed and permanent forms. 
(3) The concentration of executive power in the hands of direc- 
tors and officers leads to efiiciency in management. (4) The 
transferability of corporation securities makes it possible for 
stockholders to enter or leave the undertaking at pleasure. 
(5) The division of the securities into small units and into differ- 
ent grades and classes affords opportunities to all kinds of inves- 
tors, — the small and the large, the conservative and the ven- 
turesome. (6) All of the advantages named make it easier for 
the corporation to attract and to use efficiently large amounts of 
capital, furnished by many different investors. 

Social Aspects of the Growth of Corporations. — That corpora- 
tions do possess desirable features, from the point of view of 



1 On this account the recent development of "express trusts" as business or- 
ganizations, especially in Massachusetts, is of particular interest. These have 
"trust deeds" in place of articles of incorporation, "trustees" in place of directors, 
and "beneficiaries" in place of stockholders. In simplicity, adaptability, and in 
the protection of investors and creditors, this form of business organization has 
some real advantages over the corporation. But it has not yet been subjected to 
adequate public control, and there are some minor difficulties in its working. It 
may prove to be, however, the germ of an important development in business or- 
ganization. 

2 Exception should be made of banking and insurance corporations, in the case 
of which " double Hability " on the part of the stockholders is common. A few 
states impose some measure of personal liability upon the stockholders of all 
corporations organized under their laws. 



BUSINESS ORGANIZATION 229 

business interests, is a fact clearly evidenced by the unprece- 
dented growth of this form of business organization. In the 
main, efhciency for business purposes, for money-making, means 
efficiency from the social point of view, productive efficiency also. 
But, nevertheless, the two points of view are not identical, and 
what is desirable from one point of view is not always desirable 
from the other. 

The gap between money-making and service to society (never 
quite identical things) is distinctly widened when those in control 
of a corporation's policies subordinate the profits to be obtained 
by the sale of its products to the profits to be obtained by specu- 
lation in its securities. Many of our greatest corporations are 
directed by men to whom fluctuations in capital values (as repre- 
sented in the prices of securities) are a much more important 
source of personal income than are the net earnings of such 
corporations. The payment of unearned dividends, the non- 
payment of earned dividends, the direction of a corporation's 
policy for the benefit of the holders of one kind of security among 
the different ones issued by the corporation, the effecting of cor- 
porate combinations and reorganizations that will affect the stock 
exchange rather than the produce market, — these are some of 
the more obvious results of the unfortunate relation between cor- 
poration management and speculation in corporation securities. 

It should also be noted in this connection that the growth of 
corporations is bringing with it a subtle but very significant 
change in the nature of the institution of private property. So 
far as a large and increasing proportion of productive wealth is 
concerned, we are losing that direct relation of ownership be- 
tween men and goods which Arthur Young had in mind when he 
said, " The magic of property turns sand into gold." We often 
have, instead, several layers of corporation securities interposed 
between the ultimate owners and the ultimate objects of owner- 
ship. The effect of this will undoubtedly be to bring about the 
more thorough domination of business principles in the business 
world. Sentiment, the honored traditions of long-established 
firms, the " pride of ownership," the joy of workmanship (which 
may be felt by the employer who turns out a good product, as 



230 OUTLINES OF ECONOMICS 

well as by the workman) are bound to yield yet more completely 
to the sway of the cold logic of corporation accounts and stock 
market quotations. The adequacy of purely business principles 
as the foundation of our economic life will be tested more thor- 
oughly under the corporation form of organization than ever be- 
fore. 

Trusts. — A distinctive feature of the economic development 
of the past few decades has been the combination of individual 
corporations into larger concerns, or trusts. The " trust," in the 
technical sense, involved either giving a board of trustees the 
absolute control of the actual properties of the different con- 
cerns in the combination, or what amounted to the same thing, 
assigning to them the stock of each corporation, with its voting 
power, in exchange for " trust certificates," on which dividends 
were paid. The Standard Oil Trust of 1882 was the first impor- 
tant combination of this kind, but it was speedily followed by 
several others. In 1890, in a case brought by the state of New 
York against the sugar trust, the trust agreement was held to be 
illegal under common law.^ .Corporate combinations were not 
destroyed by this decision. They changed, however, to a more 
definitely coherent form, — that in which a single great corpora- 
tion dominates the consolidation. 

In most cases, this corporation, which is usually organized 
for the purpose, does not own the actual plants of the various 
concerns in the combination, but simply owns all or a majority of 
the stock of each. It is accordingly called a " holding company." 
The holding company exchanges its own securities for the securi- 
ties of constituent companies, or, when necessary, it buys the 
securities of the constituent companies with funds secured from 
the sale of its own securities, — sometimes by the sale of bonds 
secured by the pledge of the securities of constituent companies 
as collateral. Not only in industrial consolidations,^ but also in 

'^People V. North River Sugar Refining Co., 121 N. Y. 582. A similar decision 
was rendered two years later by the Supreme Court of Ohio in State v. Standard. 
Oil Co., 49 Ohio St. 137. 

2 A very complete list of "trusts," prepared by Mr. Byron W. Holt for the World 
Almanac (igoS), contained the names of about 250 industrial combinations, most 
of which were holding companies. 



BUSINESS ORGANIZATION 231 

railway and electric railway mergers has the holding company 
device become important. 

From the point of view of business organization the holding 
company is simply an extension of the principle of the corpora- 
tion. The holding company needs for purposes of control only 
a majority interest in the stocks of its subsidiary corporations. 
Various holding companies may in turn be combined by means 
of one larger holding company, and the process may, and does, 
go even further. A group of capitalists may, by an investment 
of $1,000,000, for example, control a holding company with 
a stock issue of $2,000,000, which in turn may control corpora- 
tions with $4,000,000 of stock outstanding,^ — ■ and some of 
these last may in their turn be holding companies. The result 
is a tremendous concentration of industrial and financial power, 
with the minimum of liability. The uncontrolled use of the 
holding company device leads to neglect of the interests of the 
minority stockholders in the various corporations concerned ; to 
difficulty in fixing the legal responsibility for corporate mis- 
deeds ; to an undesirable complexity in the economic and legal 
relations of the holders of securities in the different corporations, 
and to the subordination of industrial to speculative ends. 

The " trust problem," however, has attracted more attention 
as a problem of monopoly than as a problem of business organiza- 
tion. Combination and monopoly, it is important to note, are 
not identical things ; we may have either one without the other. 
But the movement toward combination originated in the efforts 
of business men to escape from the restraints imposed upon them 
by competition. Use has often been made of simpler forms of 
combination than the trust and the holding company. Agree- 
ments to sell only at certain prices, agreements to limit output, 
the employment in common of one selling agent, pooling (the 
distributions of orders or of profits to the parties to the agree- 
ment in predetermined proportions), and other devices have 

1 It is assumed, for convenience, that the stock in each case is worth par and 
that the ownership of half of it will give substantial control. In the case of indus- 
trial combinations ownership of all the stock of the subsidiary companies by the 
holding company is not uncommon. 



232 OUTLINES OF ECONOMICS 

been used. Such combinations are formed by contracts entered 
into by a number of individual firms, each of which retains its 
own autonomy in all other respects. These contracts are un- 
enforceable at common law=^ — being held to be "contracts in 
restraint of trade " and hence contrary to public policy — so that 
it was difficult to be sure that any one firm would abide by the 
contract any longer than it deemed it to be to its own individual 
advantage. Combinations of this sort still persist. Railroad 
rate agreements are, for example, both universal and necessary. 

But the movement toward combination which has played so 
important a part in the economic history of the past thirty years 
has been characterized especially by the organization of combina- 
tions of a more thoroughly unified type, in which each individual 
firm brought into the combination yields up its own autonomy 
and is absorbed by a corporation, usually a holding company, 
organized for the purpose. These unified combinations,. it was 
thought, would be valid at common law, and would be less 
vulnerable under the new anti-combination statutes that were 
being enacted. Their management could be made more effec- 
tive, and their comparative permanence and dependability 
made possible the adoption of business policies based on long- 
time considerations. Moreover, so long as there was public 
confidence in their success, they afforded an inviting opportunity 
for promoters to reap profits. 

The Causes of Combination. — The specific motives usually 
mentioned as the most important causes of corporate combina- 
tions are (i) the economies of large-scale business; (2) the 
elimination of purely competitive expenses (some kinds of ad- 
vertising, for example) ; (3) the power to limit output and con- 
trol prices. 

The first of these factors suggests the difficult question of the 
most profitable size of the business unit. The question should 
not be confused with that of the most economical size of the 
industrial plant. Many of our present-day business units are 
so large that they operate a number of practically duplicate 
plants. To that extent, at least, they are larger than is necessary 
to secure the maximum technical efficiency of the plant. Nor 



BUSINESS ORGANIZATION 233 

should the question be confused with that of the factors which 
bring about the condition of decreasing expenses in an industry 
at large. Certain productive advantages sometimes attributed 
to great industrial combinations — such as the power of utilizing 
highly specialized plants, equipped with highly specialized ma- 
chinery and located at the most favorable points — are advan- 
tages which do not have to wait upon combination, but which are 
not only available but certain to be developed in any large and 
growing competitive industry. Much has been said of the com- 
bination's ability to buy its raw materials on the largest scale, and 
therefore most cheaply, and of its ability to ship its products in 
large quantities, and therefore most economically. But it has 
not been shown that the combination has a marked advantage 
in these particulars over large competitive establishments, 
unless we should take account of the unfair discriminations that 
railway companies have too often made in favor of the large 
combinations. 

The real problem is whether the mere fact of combination, 
taken by itself, brings with it any real net economies in produc- 
tion. It probably very often happens that combination does 
effect some real savings. Uniform systems of accounting and 
cost-keeping can be introduced ; noteworthy economies found in 
any one of the plants can be introduced in all the plants of the 
same type ; high and uniform standards can be enforced by the 
central administration. Especially in combinations of the 
" integrated " type,^ there are undoubtedly real economies in 
the general coordination of the different successive stages of the 
industrial process, in the nice adjustment of the supply of raw 
materials and intermediate products to the demand for finished 
products, and in the adaptation of transportation facilities to 
the needs of the industry. The Standard Oil Company un- 
doubtedly effected great economies in the transportation of oil 
by its use of pipe lines, and these could hardly have been con- 
structed on so large and effective a scale if the industry had re- 
mained competitive. 

On the other hand, however, great combinations have certain 

1 See p. 88, above. 



234 OUTLINES OF ECONOMICS 

disadvantages inseparable from their size. Their economies 
are largely those of systematization and standardization, and 
these are prone to degenerate into inflexible and deadening 
routine. The very losses of competition may sometimes be in 
the long run a real social advantage. For they result in part 
from variety of experimentation and from the free scope given 
to individual initiative and individual planning. In competitive 
industry there is a continuing natural selection of the fittest men 
and the fittest methods. Nor are the best results always 
achieved by a hierarchical organization of industry, in which 
corporation ofi&cials, managers, and superintendents watch 
only over the larger and more general aspects of an industry 
and depend upon an army of subordinate employees (no matter 
how scientifically organized and directed) to attend to all. de- 
tails. There is sometimes no effective substitute for intimate 
personal supervision on the part of those primarily responsible 
for the success or failure of a business undertaking. 

Passing to the second and third general classes of motives 
that are advanced as causes of corporate combinations, it is suffi- 
cient here to note that whether purely competitive expenses and 
competitive prices are eliminated by combination depends upon 
whether the combination has any real basis of monopoly power 
over and above the mere fact of combination, which, taken alone, 
can give at most only a temporary monopoly. For a combina- 
tion without some real source of monopoly power to attempt 
to secure monopoly profits is to invite new enterprise and new 
capital to come into the industry. In other words, it is to induce 
latent competition to become active competition. 

It is plain, however, that if any or all of these three classes of 
advantages do exist in the case of a particular combination, the 
earning power of the combination will be greater than the total 
earning power of the separate concerns before consolidation, — 
a difference which will be reflected in the value of the securities 
of the holding company. It is this increment in capital value, 
due to the real or expected advantages of consolidation, that has 
been the chief cause of such combinations. The organization of 
trusts has in many cases been effected by professional pro- 



BUSINESS ORGANIZATION 235 

meters, whose connection with an undertaking does not con- 
tinue any longer than is necessary in order to secure the profits 
of consoHdation. A few great trusts like those which have 
figured in the oil, sugar, steel, and tobacco industries have been 
conspicuously successful in a business way. Many others were 
" made to sell " ; that is, were organized only in order that profits 
might be gained through the sale of their securities, and have 
been weighted down by a capitalization not justified by their 
actual earning capacity. Some of these have already fallen to 
pieces ; others have been reorganized, with diminished capitaliza- 
tion. 

" When judged in terms of the promises of their promoters their histories 
stand as striking acknowledgments of the inadequacy of mere consoHdation 
as a basis of economic efficiency. Two separate and distinct sets of causes 
can be discovered to explain why the overwhelming majority of these indus- 
trial combinations failed to prove as successful as their promoters had an- 
ticipated. One set was psychological in character and concerned with the 
difficulties attending the administrative management of a large business. 
The other was economic in character and concerned with the difficulties 
attending the creation of a business organization sufficiently powerful to 
dominate an industry in the presence of actual or potential competition." ^ 

It can hardly be held, then, that great industrial combinations 
are, what they have sometimes been called, "the natural products 
of economic evolution." Even where one has succeeded in so 
dominating a field as to establish a substantial monopoly, it has 
generally been found either that it possessed one or more of the 
specific sources of monopoly power, or that it was enabled by its 
size to avail itself of peculiarly destructive methods of com- 
petition. 

*-'^nti-trust Laws. — Most states have statutes and some have 
constitutional provisions against " combinations in restraint 

1 A. S. Dewing, Corporate Promotions and Reorganizations, p. 558. Dr. Dewing's 
conclusion, quoted above, is based on a very careful study of the more important 
reorganizations of industrial combinations. He finds the following specific causes 
of inefficiency : (i) diffusion of responsibility; (2) lack of knowledge of individual 
employees ; (3) lack of loyalty of officers and directors / (4) lack of attention to the 
laborious parts of the business by higher officials ; (5) prejudice of customers against 
" trusts." 



236 OUTLINES OF ECONOMICS 

of trade." These are aimed primarily against large combina- 
tions of the kind already described, although if strictly con- 
strued they also make illegal the whole mass of price agreements 
and trade restrictions, general and local, which are a much more 
common and characteristic feature of modern business than is 
generally supposed. State anti-trust statutes have accomplished 
but little, partly because they have often been aimed at forms 
rather than at facts, at symptoms rather than at fundamental 
causes, and partly because they have been used only sporadically. 
The experience of the federal government has shown that if the 
prosecution of illegal combinations is to be conducted success- 
fully, there must be thoroughgoing preliminary researches into 
the history and business methods of the combinations. The 
state governments have been poorly equipped for this kind of 
work. 

The Sherman Anti-trust Act of 1890 is a federal statute, based 
upon the federal power to control interstate commerce. It 
declares illegal " every contract, combination in the form of 
trust or otherwise, or conspiracy, in restraint of trade or com- 
merce among the several states, or with foreign nations." It 
also makes it a misdemeanor for any person to " monopolize, 
or attempt to monopolize, or combine or conspire with any other 
person or persons, to monopolize any part of the trade or com- 
merce among the several states, or with foreign nations." The 
most important aspect of the statute is that it gave the federal 
courts jurisdiction in these matters. The government can 
proceed under the statute in either or both of two ways : (i) by 
bringing criminal prosecutions against persons entering into 
unlawful combinations ; (2) by instituting proceedings to pre- 
vent and restrain violations of the law. A number of criminal 
prosecutions have been made, but most of these have been un- 
successful. It has been found difficult to get a jury to convict 
for an offense so abstract and general and, possibly, so common, 
as " restraint of trade." The more important results of the 
law have come from proceedings for the dissolution of unlawful 
combinations, and it is these only that we shall discuss. 

There has been much discussion of the precise meaning of the 



BUSINESS ORGANIZATION 237 

phrase " restraint of trade " as used in the Sherman Act. This 
phrase was taken from the common law, in which its usual appli- 
cation was to contracts by which a man agreed not to compete 
with certain others. When the restraint of trade involved in 
such agreements was merely incidental to some legitimate pur- 
pose, and necessary in order to carry out that purpose, the con- 
tracts have usually been deemed valid at common law. Thus, if 
two competitors form an ordinary partnership, or if one man sells 
his business to another, agreeing not to set up another business 
undertaking of the same kind (so as to protect the sale of the 
good- will of his former business), the restraint of competition 
involved in such contracts does not necessarily render them ille- 
gal. But if the direct purpose of a contract is restraint of trade 
it is invalid and unenforceable and under some circumstances 
criminal. 

Although the Sherman Act was intended to be primarily a 
weapon against great industrial combinations, it has been held 
by the courts to apply also to labor unions and railway combina- 
tions. It has never been held, however, that labor unions are 
illegal under the act because of any alleged restraint of competi- 
tion in the supply of labor. But certain activities of labor unions, 
particularly strikes and boycotts, have been condemned by the 
federal courts because such activities " interfere with the free 
flow of commerce from state to state." ^ This, it will be noted, 
is a very different thing from restraint of trade in the old com- 
mon-law sense. 

In 1897 the Supreme Court held that railroad rate agreements 
were in violation of the Sherman Act.^ An important point in 
these decisions was that neither the fact that railroad rates 
agreements had been defended by the Interstate Commerce 
Commission nor the claim that the rates agreed upon were rea- 
sonable was allowed to stand as a defense. If the direct purpose 
of such agreements, said the court, is restraint of competition, 

1 United States v. Workingmen's Amalgamated Council, 55 Fed. 605 ; the Railway 
Strike Cases, 64 Fed. 30, 749, and 67 Fed. 70s ; Loewe v. Lawlor (the Danbury 
Hatters' Case), 208 U. S. 274. 

2 United States v. Trans-Missouri Freight Association, 166 U. S. 290; United 
States V. Joint Traffic Association, 171 U. S. 505 (1898). 



238 OUTLINES OF ECONOMICS 

they are illegal, whether reasonable or not. Railroad rate agree- 
ments still exist, but no more of them have been attacked by the 
government. An epoch-making decision was that which in 1904 
ordered the dissolution of a New Jersey corporation, a holding 
company, organized to hold the stock of the Great Northern 
and Northern Pacific railroads, two " parallel and (supposedly) 
competing " lines.^ The importance of the decision is that for 
the first time the holding company, as an instrument for restrain- 
ing competition, was shown to be vulnerable to legal attack. 
But the application of the Sherman Act to railway combina- 
tions is in many ways unfortunate. Under the Interstate Com- 
merce Act we have since 1887 regulated railway rates on the as- 
sumption that railways are natural monopolies, and this has 
proved a much more effective method of dealing with unfair 
rates than has the attempt to force competition into the railway 
field. The good accomplished by the dissolution of railway com- 
binations lies in the inroads these dissolutions have made into 
the use of the holding company device, with its undue concen- 
tration of financial power and its opportunities for the unfair 
treatment of minority stockholders. But this is only an inci- 
dental result of these decisions, and lies quite outside the general 
purpose of the Sherman Act. Many large holding companies, 
in both the railroad and the manufacturing fields, are wholly 
invulnerable to prosecution as " combinations in restraint of 
trade." 

For twenty years the Sherman Act was least effective in the 
very field to which it had been particularly designed to apply. 
A few industrial pools and price agreements were declared illegal 
by the federal courts, but in the only case involving a trust of 
the modern type that came before the Supreme Court the deci- 

1 United States v. Northern Securities Co., ig3 U. S. 197. A similar decision, 
in 191 2, involving interests of even greater magnitude, dissolved the merger of the 
Union Pacific and Southern Pacific railroads (226 U. S. 61). In the St. Louis Termi- 
nal Railroad case (224 U. S. 283), also decided in 1912, a corporation owned by fif- 
teen railroads, and possessing a monopoly of railroad terminal facilities in St. Louis, 
was not dissolved, but was merely directed so to reconstruct its organization that 
new companies might participate in its ownership and be given the advantages of 
its services on equal terms with railroads then in control of it. 



BUSINESS ORGANIZATION 239 

sion was for the defendant corporation.^ For many years 
there were few prosecutions of industrial combinations. The 
government lacked properly equipped bureaus of research- and 
investigation, and the government ofhcials were apparently 
apathetic. But both of these conditions were changed during 
President Roosevelt's administration. Finally, in 1910, the 
government was successful in suits brought for the dissolution 
of two of the greatest of industrial combinations, the Standard 
Oil Company - and the American Tobacco Company.^ Possi- 
bly the most important thing in these decisions was the emphasis 
the Supreme Court placed on certain business practices of these 
companies as evidence of their monopolistic intent. Each com- 
pany had achieved a dominating position in its field, and the 
Standard Oil Company, at least, had a virtual monopoly. 
Helped at first by railroad rebates, it had consistently pursued 
a policy of monopolization, either absorbing its competitors 
or driving them out of business. The evidence showed that 
it had acquired from 85 to 97 per cent of the business of trans- 
porting, manufacturing, and selling petroleum and its products, 
and such competition as there was seems to have existed by 
its sufferance. It did not have a natural monopoly, for only 
about one ninth of the total national production of crude oil 
came from its own wells. It had certain advantages over its 
competitors, especially in its control of pipe lines and in the low 
railroad rates given to points at which its refineries were located. 
Yet it did not have a full measure of monopoly power. Ac- 
tive competition was always possible and was kept down only 
by the use of what have come to be called unfair competitive 
methods. 

Unfair competition has come to play a very important part 
in the trust problem. It includes the use of such devices as 
(i) cutting prices below cost in a locality in which competition 

1 Untied States v. E. C. Knight Co., 156 U. S. The decision in this case, in- 
volving the American Sugar Refining Company, was to the effect that a monopoly 
in the manufacture of sugar could not be held to be a monopoly in interstate com- 
merce. 

^ 221 U. S. I. 

3 221 U. S. 181. 



240 OUTLINES OF ECONOMICS 

appears ; (2) discriminating in favor of merchants who agree 
to refuse to handle or to discriminate against competitors' prod- 
ucts; (3) the use of threats and other forms of intimidation, 
(4) the employment of spies to ascertain the details of competi- 
tors' business transactions ; (5) the production of special brands 
of goods, sold at very low prices for the purpose of driving 
competitors' products out of the market ; (6) the use of sub- 
sidiary companies as bogus independent concerns. Most of 
these methods were not in themselves illegal. Some of them, 
including price-cutting on one or more parts of an establishment's 
output, are common in ordinary competitive trade. But when 
used by large industrial combinations such methods have come 
to be called " unfair," because of the purposes prompting their 
use and because of their effects. There is a very important 
difference between an effort to gain as much business as one can 
under competitive conditions and an effort to destroy competi- 
tive conditions. And methods that may be harmless when 
used by an enterprise of ordinary size become dangerously 
destructive weapons in the hands of great industrial combina- 
tions. The combination is able to wage a destructive competi- 
tive warfare because it can stand a loss at one point or on one 
part of its output large enough to send its smaller competitor 
into bankruptcy. The use of unfair methods of competition 
by the Standard Oil Company and the American Tobacco 
Company was deemed by the Supreme Court weighty evidence 
of the purpose of those combinations to monopolize "trade and 
commerce " in their respective fields. 

These decisions showed that the Sherman Act could be used 
as an efficient tool for the dissolution of great industrial com- 
binations organized and conducted with monopolistic intent. 
Since 1910 a number of successful suits have been brought for 
the dissolution of other trusts, while yet others have voluntarily 
reorganized in accordance with plans approved by the govern- 
ment.i It is too early to judge of the ultimate effects of these 
industries. There can be no doubt, however, that in a number 
of industries, including the oil and tobacco industries, there is 

1 See the Annual Reports of the Attorney General, for igio and subsequent years. 



BUSINESS ORGANIZATION 24 1 

a larger measure of normal competition than before the disso- 
lutions. 

The reorganization of industrial combinations in such a way as to comply 
with the law often presents difficult problems. Where the trust is a holding 
company it is impossible to distribute its stock holdings to the original 
owners or their heirs, for many of the holding company's own securities 
will have changed hands since its organization. At first the courts merely 
directed that the securities owned by the holding company be distributed 
pro rata among its own stockholders. But where a majority of the stock of 
the holding company was closely held by a small group of men, and where 
the holding company held a substantial majority of the stock of its more 
important subsidiary companies, this method of dissolution was unlikely 
to result in the prompt restoration of normal competitive conditions in the 
industry. More recently the dissolution plans have been more carefully 
worked out, so that no one group of stockholders is left in control of all 
the different constituent parts of the former combination. 

In 19 14 Congress enacted two new statutes, the Clayton 
Anti-trust Act and the Federal Trade Commission Act. The 
Clayton Act is designed to accomplish a number of different 
things. We can mention only its more important provisions : 

1. It definitely legalizes those activities of labor unions 
which had been declared illegal under the Sherman Act. This 
topic is discussed elsewhere in this volume.^ 

2. It prohibits the acquisition by one corporation of stock 
in another corporation when the effect may be "to substan- 
tially lessen competition " between such corporations, or ''to 
tend to create a monopoly." It also makes it illegal for a man 
to serve (i) as a director or officer of a bank in the Federal 
Reserve system and at the same time as a director or officer 
of any other bank or as a private banker, when one bank has 
liabilities of more than $5,000,000 or when both are located 
in a large city ; (2) as an officer or director of a common carrier 
and at the same time as an officer or director of a firm having 
large dealings with the carrier in securities, supplies, or contracts 
for construction or maintenance (unless under publicly super- 
vised competitive bidding) ; (3) as a director of two or more 
industrial corporations engaged in interstate commerce, if one 

1 Chap. XXIII. 



242 OUTLINES OF ECONOMICS 

has an aggregate "capital, surplus, and undivided profits "of 
more than $1,000,000 and if they are, "by virtue of their busi- 
ness and location of operation, competitors." These provi- 
sions against " interlocking " directors and ofl&cers, like the 
provision against intercorporate stockholding, have a whole- 
some purpose and may accomplish some good in particular 
cases. But so far as their effect upon industrial combinations 
is concerned they add little to the Sherman Act, as now inter- 
preted by the courts. It will be noted, however, that intercor- 
porate stockholdings and intercorporate directorates are pro- 
hibited by the Clayton Act when they may tend to lessen 
competition between the corporations directly concerned, 
even though general competitive conditions may continue in 
the industry in which the corporations are engaged. 

3. The Clayton Act prohibits certain trade practices, in- 
cluding (i) unjustifiable discrimination in the prices charged 
to different purchasers, (2) leases or sales of goods made with 
the understanding that the lessee or purchaser shall not use 
or deal in the goods of a competitor of the lessor or seller, as 
well as special discounts or rebates made upon such conditions. 
In cases under the Sherman Act the courts, as we have seen, 
had already counted the use of such practices among the evi- 
dences of an illegal purpose to monopolize an industry. And 
injunctions against their further use have been included in the 
decrees in some of these cases. If follows that in these particu- 
lars, also, the Clayton Act adds little to the Sherman Act. 

The Federal Trade Commission, established in 1914, is com- 
posed of five members, appointed by the President. It suc- 
ceeds the Bureau of Corporations, which was established in 
1903 for the primary purpose of making special investigations 
of particular corporations and combinations and of the condi- 
tions existing in particular industries. The Federal Trade 
Commission not only has large powers of investigation, but it 
has the further power to require annual or special reports from 
interstate corporations in such form and relating to such matters 
as it may prescribe. At the request of the Attorney General 
it is to investigate any corporation alleged to be violating the 



BUSINESS ORGANIZATION 243 

anti-trust laws, and to make recommendations for the read- 
justment of its business. In suits brought under the anti- 
trust acts the Commission may be asked by the court to pre- 
pare an appropriate form of decree, which is, of course, subject 
to rejection or change by the court. The importance of this 
provision is in its bearing upon the outcome of dissolution pro- 
ceedings under the Sherman Act. The drafting of a wise plan 
of reorganization for an offending combination is often an ex- 
ceedingly difficult matter, requiring not only care and judg- 
ment, but also a large amount of technical information about 
the general condition of the industry affected. Furthermore, 
the Commission is authorized to make investigations of the 
manner in which decrees in suits under the anti-trust acts are 
carried out. 

The most important power of the Federal Trade Commission 
is undoubtedly that of issuing orders restraining the use of 
" unfair methods of competition in commerce." So far as 
such methods are used as part of a general attempt to monop- 
olize an industry, the new statute adds nothing to the Sherman 
Act except a new, prompt, and efficient method of procedure. 
If this power is wisely used it should be possible in many cases 
to put a stop to aggressive monopolizing in its early stages, 
before much harm has been done. But the power committed 
to the Federal Trade Commission has even wider aspects. It 
is to be hoped that the Commission may be able to build 
up and maintain higher standards for competitive business 
methods in general ; that it may fix the lines beyond which 
one should not go in the attempt to divert trade from one's 
competitors. 

Public Policy towards Industrial Combinations. — Our 
anti-trust laws express what is undoubtedly the dominant 
public sentiment in the United States with respect to large 
industrial combinations formed with the purpose of obtaining 
a monopoly. Our policy has been one of repression, of compul- 
sory disintegration. Undoubtedly we have made many blun- 
ders in the ways in which we have formulated and enforced this 
policy. We have, in some cases, attempted to force competition 



244 OUTLINES OF ECONOMICS 

into the field of the natural monopolies ; we have often attrib- 
uted too large a significance to the mere fact of combination ; 
we have in particular attempted to cure by a sweeping prohi- 
bition of' " restraint of trade " and '' monopolizing " many 
evils that are, in their more important aspects, matters of cor- 
poration finance, rooted in the laxity of our statutes in respect 
to the organization and management of corporations. But 
this does not mean that our general policy has been fundamen- 
tally mistaken. Monopoly has yet to prove itself more efficient 
than competition. And, moreover, it is not entirely a ques- 
tion of economic efficiency. There are differences between 
monopoly and competition in their effects upon the distribu- 
tion of wealth, upon the equality of economic opportunity, and 
upon a host of economic and social relations ; and in most of 
these particulars, it is generally believed, the advantage rests 
with competition. At any rate, we are proceeding along sound 
lines in endeavoring to raise the level of competitive methods 
and to eliminate any advantages which large combinations may 
have in their power of destructive competition. This will give 
a fairer field for experimentation with respect to the forms of 
business organization really best fitted for survival. 

There are some who believe that our general policy has been 
wholly mistaken ; that we should perrnit and even encourage the 
formation of large combinations ; that we should place monopoly 
power in their hands, and that we should then subject their 
prices and their products to public control of the kind that now 
exists in the railway field. Now there is, in fact, no good reason 
why our notions of what constitutes a " public calling," or a 
" business affected with a public interest," properly subject 
to rigid public control, should not be extended so as cover all 
natural monopolies. But to regulate prices in any industrial 
field, not naturally monopolistic, would be an exceedingly diffi- 
cult and complex undertaking. It would also be difficult to 
define the terms on which new capital and new enterprise might 
come into the "regulated " industry. And there is, as yet, 
no proof that this proposed change in policy would, if put into 
effect, result in any large economic or social gains. 



BUSINESS ORGANIZATION 245 

Federal Control of Corporations. — The unfortunate effects 
of the lack of uniform state requirements in such matters as 
purposes of incorporation, corporate powers, qualifications 
and responsibilities of promoters and directors, capitalization, 
and the like could in large measure be remedied by federal 
action. The Clayton Act touches only incidentally upon this 
field. Its provisions relating to incorporate stockholdings 
and interlocking directorates were framed with reference 
merely to the problem of the preservation of competitive con- 
ditions. What is needed is a federal statute dealing thoroughly 
and systematically with the promotion, organization, and 
management of corporations engaged in interstate commerce. 
Canal, railway, and bridge companies have in the past been 
chartered by the federal government, just as national banks are 
now. It would be legally possible and economically advisable 
to require at least a, federal license from all corporations engaging 
in interstate commerce. Moderate and just requirements as 
to publicity, capitalization, and other things might very well 
be imposed as the price of federal license. Aside from the 
present lack of uniformity in state laws, the mere size of modern 
business corporations and the interstate scope of their opera- 
tions make it difficult for any individual state or states to 
control them efficiently. 

Industrial Combinations in Other Countries. — A move- 
ment toward combination in some form has manifested itself 
in practically every country which has large industries of the 
modern type. In England, however, the movement has made 
much less headway than in the United States. This may be 
attributed in part to the fact that England's " company laws " 
are not so lax as are the corporation laws of many of our states, 
in part, possibly, to the absence of a protective tariff, and in 
part to the highly specialized character of English industries. 
During the past twenty or thirty years, however, a number of 
important combinations have been formed in England, but 
only a few of these have been successful. An English combina- 
tion, it may be noted, has an international monopoly of sewing 
cotton. England has no statute forbidding combinations. 



246 OUTLINES OF ECONOMICS 

but the contracts by which " combinations in restraint of trade " 
are formed will not be enforced by the courts. 

In Germany and in certain other countries of continental 
Europe the dominant form of combination is the Kartell. 
This resembles a pool more than it does the thoroughly central- 
ized industrial combinations of the United States. The Kartell 
itself is, however, usually organized as a joint-stock company. 
The individual companies constituting its membership continue 
as independent producing establishments. The Kartell con- 
trols sales, prices, output, and the distribution of orders and of 
profits. Opinions in Germany with respect to the success of 
the Kartells is greatly divided. On the one hand it is claimed 
that they have eliminated many of the wastes of competition and 
that they have been especially active and successful in securing 
sales in foreign markets. On the other hand it is charged that 
they have discriminated against home consumers by selling 
abroad at lower prices than they charge at home, and that they 
even go so far as to sell at very different prices in different part 
of Germany, utilizing, as far as possible, the principle of " charg- 
ing what the traffic will bear." In 1906, ,when a government 
investigation was made, there were 384 Kartells in Germany, and 
many new ones have been organized in subsequent years. Note- 
worthy among the German Kartells have been the Rhenish- 
Westphalian Coal Syndicate (of which the Prussian govern- 
ment, as a large mine owner, was for a short time a member) 
and the Steel-works Association. 

QUESTIONS AND EXERCISES 

1. What are the terms under which corporations are chartered in your 
own state? What anti-trust laws are in force there? 

2. Explain the various items in the published balance sheet of some in- 
dustrial corporation. 

3. What limitations should be attached to the statement that "a cor- 
poration is a fictitious person " ? 

4. Does the word "capital" mean the same thing in accounting and in 
economics? 

5. Report on the history of one of the following: United States Steel 
Corporation ; American Sugar Refining Company ; American Tobacco 



BUSINESS ORGANIZATION 247 

Company; International Harvester Company; United States Leather 
Company ; Rhenish-Westphalian Coal Syndicate. 

6. What advantages has a large plant? a large business unit? a 
monopoly ? 

7. What special burdens are imposed upon corporations? Has the 
corporation any other disadvantages as a form of business organization ? 

8. In what respects do the Clayton Anti-trust Act and the Federal Trade 
Commission Act cover the same ground ? 

REFERENCES 

Bureau of Corporations. Special Reports on various industries. 

Carter,* G. R. The Tendency towards Industrial Combinations. 

Clark, J. B. and J. M. The Control of Trusts. 

Dewing, A. S. Corporate Promotions and Reorganizations. 

DxjRAND, E. D. The Trust Problem. 

Federal Trade Commission. Annual and Special Reports. 

Gerstenberg, C. W. (editor). Materials of Corporation Finance. 

Haney, L. H. Business Organization and Combination. 

Jenks, J. W. The Trust Problem. 

Lough, W. H. Corporation Finance. 

Lyon, W. H. Capitalization, a Handbook of Corporation Finance. 

Meade, E. S. Trust Finance; Corporation Finance. 

Orth, S. p. (compiler). Readings on the Relation of Government to Prop- 
erty and Industry, Parts iv, viii, ix. 

Railroad Securities Commission. Report. 

Ripley, W. Z. Railroads : Finance and Organization; (editor) Trusts, 
Pools, and Corporations. 

Stevens, W. S. (editor): Ifidustrial Combinations and Trusts. 

Van Hise, C. R. Concentration and Control. 

Wyman, Bruce. The Control of the Market. 

Young, A. A. "The Sherman Act and the New Anti-trust Legislation," 
Journal of Political Economy, vol. xxiii, pp. 210-220, 305-326, 417-436. 



CHAPTER XIV 
MONEY 

The vast system of exchange, which is the most characteristic 
single feature of present-day economy, rests upon the use of 
money. We have seen that some economic writers have pic- 
tured an imaginary primitive state of " barter economy " ; in 
which, before the use of money, goods were exchanged directly 
for goods. But what Httle definite information there is on this 
point leads us to the belief that about as soon as men began to 
exchange things, and consequently to attribute exchange value 
to them, they began to use some kind ojf money — some commod- 
ity or commodities for which things were generally exchanged, 
and in terms of which the values of other things were generally 
stated. 

The earliest forms of money were crude and simple, but they 
sufficed to meet simple needs. As exchange economy has ad- 
vanced to the present complex division of labor, the monetary 
system has developed pari passu, the most conspicuous feature 
of this development in modern times being the growing impor- 
tance of credit as a means of effecting exchanges. Industrial and 
commercial progress has led to monetary progress, and has, in 
turn, been stimulated and made possible by it. 

Metallic Money. — The earliest and simplest forms of money 
were commodities. Particular commodities came to serve as 
money, not because they were arbitrarily designated as such 
by king or chieftain, but because they possessed some properties 
which made them exceptipnally exchangeable. In some cases 
a primitive community came to use a commodity as money be- 
cause it was something for which they had a dependable " for- 
eign market " — something, that is, which they customarily sold 
to other communities in exchange for their products. In other 

248 



MONEY 249 

cases a commodity which a community did not itself produce, 
but which it got only in the course of trade with other com- 
munities, became the money commodity. Or, if for any reason 
a particular commodity came to be particularly esteemed as a 
mark of wealth or a badge of social prestige, it was likely to used 
as money. But whatever the original ground of the choice, a 
commodity which a community once began to think of as money 
had its exchangeability, and consequently its suitability for 
monetary uses, increased in a cumulative way, just as today 
most of us are willing to accept anything as money which we 
think we can use as money. 

A great variety of commodities have at one time or another 
been used as money. Some typical examples are cattle, grain, 
furs, oil, salt, tobacco, ivory, shells, and tea. But with the ad- 
vance of political and economic civilization the metals have, 
through the process of the survival of the fittest, proven them- 
selves everywhere to be preeminently and indisputably the best 
money commodities. Copper, silver, and gold have each in turn 
been chosen as the principal money metal of the civilized world, 
the transition from the cheaper to the dearer metals indicating 
the growth of exchange and of wealth and the consequent need 
of larger money units. 

Metals, and especially the precious metals, have certain quali- 
ties that give them a peculiar fitness to serve as money. They 
are durable, easily recognized and tested, and may be divided 
into homogeneous units of convenient form and weight. More- 
over, as compared with most other commodities, the precious 
metals are relatively stable in value. This arises in part from 
their durability, for any one year's output of the mines makes but 
a comparatively small addition to the total stock of metallic 
money, and in part from the nature of their non-monetary uses, 
for the demand for commodities that minister to our tastes for 
ornament and display is much more elastic than the demand for 
necessaries of life. 

Coinage. — When metals were first used as money, they passed 
from hand to hand simply by weight, or, in some cases, in the 
form of ornaments. Coinage speedily developed, however, as 



250 OUTLINES OF ECONOMICS 

a convenient way of certifying to the weight and fineness of 
money units. ^ 

Such a guarantee is naturally of little avail unless it is generally 
recognized as authoritative. On this account the coinage of 
money has almost universally been regarded as a prerogative of 
the sovereign. In England, even under the divided sovereignty 
of the Middle Ages, the coining of gold and silver was generally 
a privilege belonging to the king alone. The lesser feudal lord 
and the chartered cities issued token coins, made of the baser 
metals, and intended especially for local use, but if they possessed 
the right of coining the precious metals, it was through a special 
grant of the king. 

The Meaning of " Money." — In modern economic life 
many things in addition to coined metals are included, and 
properly included, under the name of money. There is, how- 
ever, no definite line of demarcation between the things which 
are money and the things which are not money, consistently 
followed in common usage, or even in economic writings. But 
we may agree, to begin with, that money is what we exchange 
for things when purchasing them, and that sellers are willing to 
accept it, a.t stated prices, in exchange for their goods. Then, 
however, we have to take account of the fact that many ex- 
changes are credit transactions ; that is, that the immediate 
equivalent given in exchange for a thing is a promise to pay a 
certain amount of money. This suggests that we should dis- 
tinguish between " money " and " credit instruments." But 
when we push our analysis a little further we find that the ele- 
ment of credit is found in many of the things that we ordinarily 
call money, even, as we shall see, in some kinds of metallic 
money. 

A useful and important distinction, however, is implied in the 
very common practice of restricting the use of the name 
" money " to those instruments of general acceptability which 

1 The names of many ancient coins and of some modern ones are also the names 
of weights, although it has generally happened that through successive debasements 
of the coinage these names have lost their original significance. The Greek talent, 
the Jewish shekel, the Roman as, the Chinese tael, the Enghsh pound, and the 
French livre are familiar examples. 



MONEY 251 

pass freely from hand to hand as media of exchange. The particu- 
lar things thus to be counted as money vary for different periods 
and for different countries. In the United States this generally 
acceptable medium of exchange includes the metallic money 
coined by the federal government, the paper money issued by it, 
and bank notes. Checks drawn by individuals upon their bank 
accounts are not money, or money instruments, in this sense, 
because they do not pass freely from hand to hand as media 
of exchange. They can be used only in making payments to 
persons who have confidence in the honesty and solvency of the 
one who tenders the check for payment. Some things that 
are part of the generally acceptable media of exchange are them- 
selves promises (on the part of the government or of banks) 
to pay certain other forms of money on demand. But the 
important point is that the acceptability of such things does not 
depend upon the honesty or solvency of the person who tenders 
them in payment. So long as we have confidence in the solvency 
of the government and the banks, their coins and notes, issued 
in convenient and easily recognizable forms and denominations, 
are generally acceptable media of exchange, and, as such, are 
money. This meaning of the word has the sanction of a very 
common and prevalent usage ; it corresponds, moreover, to the 
technical definition given to the word by many economic writers, 
and to the official usage of the United States Treasury. In this 
chapter the word " money " will be employed in this restricted 
sense of money instruments of general acceptability. 

But the word is also often used in a much broader sense. We 
speak of " money funds," the " money market," " money ex- 
penditures," " investments of money," etc. And yet the 
" money market " is not primarily a place in which the generally 
acceptable media of exchange are bought and sold, nor is the 
fact that one's " money expenditures " amount to a given sum 
to be interpreted as meaning that one has actually paid out this 
amount in the generally acceptable media of exchange. Money, 
in this broad sense, includes credit in the form of rights to receive 
money (in the narrower sense just defined) on demand. It is 
these rights that are bought and sold in the money market and 



252 OUTLINES OF ECONOMICS 

it is by transfers of these rights that a very large proportion of 
the aggregate annual payments for goods and services are made. 
A payment made by a bank check is, for example, a transfer 
of a right of this kind. 

The Media of Exchange. — Some writers have made a distinc- 
tion between the function which money performs as a medium of 
exchange, and its function as a measure of value. These are not, 
however, two different functions, but merely two different 
aspects of the same thing. By the very process of exchanging 
a commodity for money, we of necessity " measure " its value 
in terms of money, and only as a medium of exchange does money 
measure value. We may speak of a pound weight as an instru- 
ment used in weighing or as a measure of weight, but we would 
all recognize that these are merely two aspects of one function. 

In the United States the actual media of exchange in terms of 
which we " measure values " (or more accurately, state prices) 
comprise a variety of coins, made from different metals, together 
with several kinds of paper money of many different denomina- 
tions. But all these different forms of money are alike in name, 

— that is, they are dollars, or multiples or fractions of a dollar, 

— and moreover, these various kinds of dollars are not distin- 
guished, one from another, in the price lists. This familiar and 
very satisfactory condition of uniformity in the units in which 
we state prices does not, however, suggest to us the real nature 
of money in the way that a less perfect monetary system would. 

It would be possible to have a number of different monetary 
units, just as the weight or size of an object may be stated in 
terms of either the metric system or the English system of 
weights and measures. In fact, before the United States had an 
adequate monetary system of its own, the actual media of ex- 
change consisted largely of English, French, Spanish, and Portu- 
guese coins, and there were as many different ways of stating 
prices as there were varieties of money. ^ Nor does the mere 

1 An instructive bit of monetary experience may be found in the eflforts of some 
of the colonies to reduce this foreign money, especially Spanish money, to the 
English system of pounds, shillings, and pence, in which accounts were generally 
kept. They \yere not content with a simple official statement of the actual ratios 
between the different value units, but sought to give an artificially enhanced value 



MONEY • 253 

name of " dollar " give to different pieces of money a uniform 
purchasing power. The silver dollar of Mexico will buy only 
about half as much as the silver dollar of the United States, al- 
though it is of approximately the same size. More significant, 
however, is the fact that in the United States we have had at 
different times '' dollars " of unequal purchasing power. 

What is it, then, that gives uniformity to the dollar as a price- 
recording unit in our present monetary system? To say that 
various kinds of money are equal in value because they will pur- 
chase the same amounts of goods is, obviously, to argue in a circle. 
But the answer is found in the fact that they are interchangeable, 
and so long as any number of kinds of money, all named in dollar 
units, are freely exchangeable, dollar for dollar, it is impossible that 
domestic prices stated in terms of one kind of money should be 
higher or lower than domestic prices stated in terms of any other 
kind of money. We do not refer here to the fact that different 
kinds of money are exchanged for each other at par in business 
transactions and in banking, for this is a result, rather than a 
cause, of their parity. The exchangeability that underlies the 
parity of our different kinds of money is maintained by the 
federal government. 

All coins smaller than a dollar are by law exchangeable at the 
United States Treasury for " lawful money," which includes gov- 
ernment notes, silver dollars, and gold coins. Government 
notes, in turn, are simply promises to pay, which are redeemable 
in gold at the government treasury. While there is no definite 
legal mandate requiring the redemption of silver dollars in gold, 
yet the currency act of 1900 makes it the duty of the Secretary 
of the Treasury to maintain all other forms of money at a parity 
with gold — a requirement which means that he would have to 
redeem silver dollars in gold if such action should at any time be 

to the foreign coins by increasing the number of shillings to which they were to be 
considered equivalent. The result was not, however, an increase in the value 
of the coins, but a decrease in the value of the nominal "shilling" in which accounts 
were kept. This was the origin of the now rapidly vanishing use of the word "shil- 
ling" as equivalent to 125 cents in some localities and to i6f cents in others. The 
student may find an instructive parallel in this experience and the official statement 
of coin values by which sovereigns tried to retain their seigniorage profits. 



254 ■ OUTLINES OF ECONOMICS 

Money in the United States: June, 30, 1915^ 





In Treasury, 

Mints, and 

Federal 

ReSEBVE BANIfS 


In Other Banks 

and in 
Circulation 


Total 


Gold coin and bullion . 
Silver dollars .... 
Subsidiary silver . . . 


$1,395,405,553 

503,624,499 

26,164,29s 


$590,133,619 

64,647,156 

159,265,955 


$1,985,539,172 
568,271,65s 
185,430,250 


Total metallic . . . 


$1,925,194,347 


$814,046,730 


$2,739,241,077 


United States notes . . 
Federal reserve notes . 
National bank notes . 


$14,338,770 

3,885,850 

33,880,546 


$332,342,246 
80,374,650 

785,393,047 


$346,681,016 

84,260,500 

819,273,593 


Total notes .... 


$52,105,166 


$1,198,109,943 


$1,250,215,109 


Aggregate metallic 
and notes . . . 


$1,977,299,513 


$2,012,156,673 


$3,989,456,186 


Gold certificates . . . 
Silver certificates . . . 
Treasury notes of 1890 

Total certificates and 


$ 100,861,170 

11,488,605 

9,313 


$1,072,847,819 

481,970,395 

2,244,687 


— 


notes 


$112,359,088 


$ 1,557,062,901 


— 


Aggregate 2 .... 


— 


$3,569,219,574 


$3,989,456,186 



needed to maintain their parity. Gold certificates and silver cer- 
tificates are simply a mechanism for putting gold and silver money 
into circulation in convenient form. They are analogous to ware- 
house receipts, because they represent gold coins and silver dollars 
that are stored in the government treasury to the full amount of 
the certificates issued, and which may be obtained at any time in 
exchange for the certificates. Bank notes (including federal 
reserve notes and national bank notes) are redeemed by the fed- 
eral treasury, which for this purpose acts as an agent of the 
banks which have issued the notes. In practice the government 
is continually receiving all kinds of money, including silver dol- 

^ Finance Report, igis, p. 314. 

^ This aggregate does not include "minor coins," principally bronze one-cent 
pieces and nickel five-cent pieces, of which there were about $60,000,000 outstand- 
ing on June 30, 1915. 



MONEY 255 

lars, and exchanging other kinds of money for them. The sig- 
nificant thing is that all other kinds of money are exchangeable, 
directly or indirectly, for gold coin. 

The Monetary Standard. — In the case of gold coin, there is 
a further kind of exchangeability — the unlimited and free con- 
vertibility of gold coin and gold bidlion. So long as any one can 
secure gold coin from the mints in any amount for the same weight 
of gold bullion of standard fineness, and so long as gold coin can 
be freely melted down into gold bullion, it is impossible that there 
should be any appreciable difference between the value of a gold 
coin and the value of its metallic content. We have, then, not 
only the interchangeability of all parts of the circulating medium, 
but also the positive physical identity of one part of it and the 
material of which this part is made. 

Gold coins, because their value as bullion is equal to their value 
as coins, constitute standard money. The gold dollar weighing 
25.8 grains, and containing 23.22 grains of fine gold is by law the 
monetary unit, that is, the dollars in terms of which prices are 
stated are gold dollars or are maintained at a parity with gold 
dollars. The coinage of the gold dollar was discontinued in 
1890, but the gold coins that are minted contain precisely this 
amount of gold per dollar. Gold, whether in coin or bullion, 
constitutes the monetary standard, for the value of any dollar must 
be equal to the value of the gold in a gold dollar. The recording 
of prices in terms of dollars through the exchange of goods and 
services for money of different sorts, the maintenance of the 
parity of dollars in all varieties of money through their exchange- 
ability, and the automatic equating of the value of the dollar 
to the value of 25.8 grains of gold bullion ; — these are the fun- 
damental facts of our monetary system. 

Seigniorage. — Sovereigns have in the past very often viewed 
the monopoly of coinage as an opportunity for personal profit. 
By calling in the stock of metallic money in the country for re- 
coinage, they have frequently reduced the weights of coins with- 
out changing their names, thus increasing the number of coins, 
so that a handsome profit was netted for the royal treasury. 
Debasement of the currency was a favorite financial expedient 



256 OUTLINES OF ECONOMICS 

of Henry VIII, of England, and of Philip the Fair and Louis XIV, 
of France. 

Somewhat less reprehensible in theory, although amounting to 
about the same thing in its effects, was the common practice of 
making a charge for the coinage of standard money, called 
seigniorage. This practice was based on the idea that it was 
possible to maintain a difference between the value of a coin and 
the value of the bullion put into it.^ A great deal has been 
written about the possibility of seigniorage, for the subject is one 
that involves considerations that are fundamental in monetary 
theory. It has been often said, for example, that it is the 
" government stamp," rather than the metallic content, that 
gives value to a coin. Leaving aside the matter of limited or 
subsidiary coinage (which will be considered presently), we may 
dispose of this statement by saying that if it means that the use 
of certain metals as money creates a demand for them that would 
not otherwise exist and thus increases their value, it is a truism ; 
but if it means that in coinage we can add an arbitrary and in- 
tangible element of value to the value of the metallic content 
of standard coins, the statement is a misleading doctrine that 
has been disproved by the monetary experience of almost every 
country. 

There is, however, a stronger statement of the theory of seign- 
iorage. If the only way in which I can convert bullion into a 
medium of exchange is by being content with 750 ounces of 
money for every 1000 ounces of bullion I take to the mint, will 
not the coins have a value one third greater than that of the 
metal they contain? May not their ''metallic content" be 
said to be, in a figurative sense, one third more than their weight 
because they cost me that much more in bullion? If their bul- 
lion value sinks below this point, bullion will not be brought to 
the mint, as it will be worth more than the coins one can get 
for it ; just as when the value of the coins rises above this point 
the supply of bullion would be stimulated so that as a result the 
value of the coins would tend to maintain this fixed relation 

1 Under Philip the Fair, the seigniorage charge went as high as 50 per cent. 
Charges of from 2 to 15 per cent were more common. 



MONEY 257 

to the value of bullion. As a matter of fact, it is probable that in 
a completely isolated community a strong and stable govern- 
ment could, through wise and careful regulations, maintain a 
constant rate of profit on the coinage, without endangering the 
stability of the monetary system. 

The fundamental difficulty with seigniorage, however, was 
found in practice to be that in foreign trade coins passed current 
only as bullion, so that when seigniorage was charged, the prices 
of imported goods, expressed in money, were necessarily higher 
than their prices expressed in bullion, by an amount equal to 
the seigniorage. It was impossible that one ratio of exchange 
could long be maintained between coined money and bullion in 
domestic trade and another ratio of exchange in foreign trade. 
The interdependence of the prices of all kinds of goods prevented 
that. Money prices, in general always rose ; that is, the value 
of the coins sank to the level of the value of the bullion they 
contained. Under these conditions no one would voluntarily 
undergo the loss inseparable from taking bullion to the mint 
for coinage, and with the cessation of coinage the profits from 
coinage stopped. Every possible expedient, short of the abso- 
lute prohibition of foreign trade, was tried by sovereigns in their 
efforts to retain their profits.^ But market forces were found to 
be stronger than royal regulations, which at best only served to 
retard somewhat the depression in the value of the official coin- 
age. About the only effective way of getting profits from the 
coinage was for the sovereign to admit that the coins in circula- 
tion possessed only their bullion value, and then to call in the 
currency for recoinage into smaller pieces, in the manner that 
has already been mentioned, thus starting afresh with a new 



1 The use of any other circulating medium than the official on-e was prohibited ; 
no one was allowed to sell imported gold or silver, whether in bullion or coin, save 
to the royal mint; if there were mines within the country, they were sometimes 
prohibited from disposing of their products except to the royal mint; goldsmiths 
were forbidden to melt down coin or to purchase more bullion than they needed, and 
this they were forbidden to buy at less than the mint price ; restrictions were placed 
on the export of bullion ; these and other similar methods were tried, but all to no 
avail. Cf. W. Lexis, article "Miinzwesen," in Handw'drterbuch der Staatswissen- 
schaften. 

S 



258 OUTLINES OF ECONOMICS 

seigniorage charge. The result was invariably a repetition of the 
process of a more or less rapid depreciation in the purchasing 
power of the coins, leading often to further debasements of the 
currency. 

Modern nations have abandoned the attempt to secure profits 
from their monopoly of the coinage. Since 1666 England has 
made no charge whatever for coining bullion into standard 
money .^ Most of the countries of continental Europe make a 
charge just sufficient to cover the expense of coinage. This 
charge is sometimes called seigniorage, but it is usually, and 
more properly, called brassage. The United States made no 
coinage charge until 1853, when a charge of one half of 
I per cent was made for coining standard money. This was 
reduced in 1873 and was abandoned entirely in 1875. At pres- 
ent the United States exchanges gold coins, weight for weight, 
for bullion of standard fineness (nine tenths gold, one tenth cop- 
per) brought to the mint in lots of one hundred dollars or more 
in value. For crude bullion, or bullion not of standard fineness, 
gold coins are exchanged containing as much fine gold as is 
contained in the bullion, less a trifling charge for assaying, re- 
fining, and for the alloy. ^ 

Instead of viewing coinage as a profitable prerogative of the 
government, we have come to view it as a government duty, to be 
performed at government expense. The question of seigniorage 
versus gratuitous coinage is no longer a live issue. But the stu- 
dent who has grasped the significance of the lesson contained in 

1 In practice most of the gold bullion coined in England is supplied to the mint 
by the Bank of England, which is required by law to purchase it at the minimum 
price of £3 175. gd. per ounce. An ounce of bulUon makes £3 175. io\d. in gold 
coin, the difference going to compensate the bank for the delay involved in getting 
the bullion coined at the mint. In the United States the waiting devolves upon 
the government, for gold coins, or, at the option of the depositor, checks upon 
United States subtreasuries or upon depository banks are paid to depositors as soon 
as their bullion can be weighed and assayed. 

2 The coinage mints are at Philadelphia, San Francisco, and Denver. In addi- 
tion there are bullion-purchasing mints (not now operated as coinage mints) at 
New Orleans and Carson City, and assay ofBces at New York, Boise, Helena, St. 
Louis, Deadwood, Salt Lake City, and Seattle, which receive bullion on the same 
terms as the mints, plus an additional charge of one eighth of i per cent. 



MONEY 259 

the history of seigniorage has taken an important step toward 
the understanding of monetary theory. The coinage of standard 
money is now in law, and always has been in fact, a device for 
dividing the standard money metal into convenient units of cer- 
tified weight and fineness. 

Limited Coinage. — Gold is the only metal which is made into 
coins by the United States government for any one who deposits 
bullion at the mints or assay offices. All other coins are made 
from metal purchased from time to time for that purpose as Con- 
gress may direct. In none of these coins is the bullion worth as 
much as the coin. In 1878, when the United States began the 
limited coinage of silver dollars, the value of the 3 7 if grains of 
pure silver in a silver dollar was about 89 cents. The value of 
silver declined steadily until 1902, when 371 J grains of silver were 
worth only 41 cents. Since that time there has been a slight 
upward movement, but nevertheless in 191 5 the bullion value of 
a silver dollar was only about one half its value as a coin. The 
bullion value of the smaller silver coins is still less, for they con- 
tain but 347.22 grains of silver to the dollar, while the bullion 
value of our nickel and bronze coins is yet smaller, relatively. 

Such coins are sometimes called " token coins," the implica- 
tion being that the fact that they pass from hand to hand at their 
full nominal value is merely a matter of habit or usage, supported 
by general acquiescence. More accurately, however, they are 
credit coins, because the excess of their coin value over their 
bullion value depends ultimately, as we have seen, upon the good 
faith and credit of the government, evidenced by their redeem- 
ability in gold. If, for example, a catastrophe should overthrow 
the present federal government, and if the new government 
should refuse to recognize the obligations of the old, nothing 
could prevent these coins from sinking to their bullion value. 

A very considerable profit accrues to the government from this 
limited coinage. The difference between the amount paid for 
silver bullion from 1878 to 1907, and the value of the coins made 
from it, amounted to $143,000,000. In the accounts of the fed- 
eral treasury this profit is called seigniorage, but it should be 
carefully distinguished from real seigniorage, — a charge ex- 



26o OUTLINES OF ECONOMICS 

acted for the conversion of standard bullion into standard coin. 
If the federal government should issue a general balance sheet of 
the kind used in corporation accounting, the credit element in 
its outstanding limited coinage would properly appear as a liabil- 
ity, which might be greater or less than the profits that had ac- 
crued on such coinage, depending upon whether the present value 
of the bullion in the coins happened to be greater or less than the 
prices which the government had paid for it. 

Bimetallism. — A monetary system like the present one of the 
United States is a single standard system, because only one com- 
modity is used as a monetary standard. The double standard sys- 
tem, under which two different commodities serve concurrently 
as legal monetary standards, has, however, been used in the past 
by many governments, including our own, and its superiority 
over the single standard system has been alleged by many advo- 
cates. Practically the only commodities that civilized nations 
have used as monetary standards in modern times are gold and 
silver. The question of the double standard resolves itself, 
accordingly, into the question of the bimetallic standard, which 
means in practice the unlimited coinage of both gold and silver. 

Bimetallism does not mean, in theory, as might be supposed, 
the establishment of two different monetary units of different 
names, one defined as a certain amount of silver, the other de- 
fined as a certain amount of gold, prices being stated accord- 
ing to convenience in terms of either unit. On the contrary, 
it contemplates the establishment of one nominal unit, such as 
the dollar, to be defined at the same time as either a definite 
amount of gold or a definite amount of silver. More concretely, 
this means the opening of the mints to the unlimited coinage of 
both gold and silver into dollars, or dollar multiples, the amount 
of silver in a silver dollar and the amount of gold in a gold dollar 
being established by law. 

Many of the arguments that have been advanced by bimetal- 
lists have related to the alleged immediate advantages to be 
secured from the adoption of the double standard under particu- 
lar conditions of time and place. One argument, however, of 
more general significance is based on the probable greater stabil- 



MONEY 261 

ity of prices under the double standard. Silver and gold are pro- 
duced under somewhat different conditions, and are used for 
somewhat different purposes. It has been maintained that 
tendencies toward fluctuations in prices stated in silver and in 
prices stated in gold would, therefore, be as apt to be in opposite 
directions as in the same direction, and that so far as they were 
in opposite directions they would tend to counterbalance each 
other. 

Most opponents of bimetallism, while admitting that, if 
feasible, it might possess some advantages, deny its possibility. 
The difficulty is, they maintain, that while the ratio of the weight 
of gold in the monetary unit to the weight of silver in the mone- 
tary unit has to be fixed and definite, the ratio at which gold 
exchanges for silver is not fixed and definite, but is subject to the 
fluctuations of the market. If one metal is relatively underap- 
praised and the other relatively overappraised by the legal ratio, 
the result will be that only the overappraised metal will be 
brought to the mint for coinage, for the underappraised metal 
will be worth no more than the overappraised one as coin, but 
will be worth more as bullion. The actual result will be, in such 
a case, not a bimetallic standard, but a single standard composed 
of the metal which, at the mint ratio, is the cheaper. Moreover, 
if, by a change in the market ratios of exchange of the two metals, 
this one in turn becomes underappraised by the mint ratio, the 
standard coins composed of that metal that are already in use 
will disappear from circulation, being hoarded, melted down, or 
exported, and the other metal will take its place as the actual 
standard of value. 

The opponents of bimetallism claim, in short, that it en- 
counters a formidable obstacle in the principle known as 
Gresham's law, which is usually summarized with rough accuracy 
in the statement that " bad money drives out good," or that 
" the cheaper money drives out the dearer." More definitely, 
this means that domestic payments will be made, as far as pos- 
sible, in the money which can be used to less advantage for other 
purposes, and that no one will exchange relatively expensive 
bullion for coins at the mint when coins of an equal nominal 



262 OUTLINES OF ECONOMICS 

value and (for most purposes) of equal purchasing power can be 
obtained in exchange for relatively cheaper bullion. Sir Thomas 
.Gresham is said to have come to this conclusion as a result of 
his observations of the difficulties encountered by Queen Eliza- 
beth in her attempts to improve the condition of the debased, 
worn, and mutilated coinage bequeathed to her by her prede- 
cessors. But the operation of the principle had previously been 
noted by various writers. 

All but the most extreme bimetallists would admit the impossi- 
bility of establishing and maintaining a coinage ratio between the 
two metals that would differ by any wide margin from the initial 
ratio at which they exchanged in the market, but they maintain 
that a mint ratio established as nearly as possible to the prevail- 
ing market ratio will have a steadying influence upon the latter 
that will tend to prevent any wide divergence between the two. 
If the market ratio should change to such an extent that it 
would not pay to use one of the metals as money, more of the other 
metal would be used for monetary purposes, thus decreasing 
the supply of it available for other uses and consequently en- 
hancing its relative value. The net effect of this " compensa- 
tory action of bimetallism" would be, it is claimed, a tendency 
toward the equilibrium of the market ratio of exchange of the 
two metals at the coinage ratio. 

The appeal to history has been used both by bimetallists and 
their opponents. The claim of the monometallists that legal bi- 
metallism is apt to mean actual monometallism, with the rela- 
tively cheaper metal as the standard, has been substantiated 
many times in the monetary experience of different nations. 
The automatic change from one single standard to the other, 
following a change in market rates of exchange, is also a phenom- 
enon that has been illustrated by a large number of concrete 
cases. On the other hand, the bimetallists are able to point 
to some fairly successful bimetallic systems, such as that of 
France in the first half of the nineteenth century. But it is a 
significant fact that no real bimetallic system has been able to en- 
dure for any considerable time except when the annual produc- 
tion of gold and silver was relatively small and relatively stable. 



MONEY 263 

and where international trade was a relatively unimportant item. 
There is no scientific student of monetary problems who believes 
that it would be possible for any nation independently to main- 
tain the double standard under the present conditions of a large 
and fluctuating annual production of the precious metals, coupled 
with an international commerce of vast proportions. 

International bimetallism, that is, the adoption by most of the 
leading nations of a bimetallic standard, at a ratio fixed by inter- 
national agreement, has had many supporters, even among those 
who do not believe in the practicability of national bimetallism, 
and representatives of different nations have assembled in several 
international monetary conferences for the discussion of this 
subject. International bimetallism would remove one difficulty 
experienced in the attempts made by different nations to main- 
tain independent bimetallic systems at even slightly differing 
ratios, — and that is the tendency for each metal to flow from 
the countries in which it is relatively underappraised in the mint 
ratio to the countries in which it is relatively overappraised. 
Other difficulties, however, would still remain, and the possi- 
bility of maintaining an actual bimetallic standard even under 
international agreement, supposing that were possible, is open 
to very serious doubt. 

The waning of public interest in the question of bimetallism in 
recent years is of great significance, because it indicates that the 
real moving forces behind the bimetallist propaganda have not 
been any real or assumed points of superiority of general sig- 
nificance that may be imputed to a double standard, but rather 
that certain specific results that would flow from the adoption of 
bimetallism at a particular time and place have been desired. 
More specifically, bimetallism has been supported by those who 
have desired " cheaper money," and these have been particu- 
larly active when the money in actual use has been increasing 
in its purchasing power, that is, when prices in general have been 
decreasing. The recent great increase in the world's production 
of gold has, temporarily at least, taken bimetallism out of the 
list of economic problems of general public interest. 

Bimetallism in the United States. — The national monetary 



264 OUTLINES OF ECONOMICS 

system was established by act of Congress in 1792.^ The mint 
was opened to the free and unHmited coinage of both gold and 
silver, the silver coins containing 37 ij grains of fine metal per 
dollar, and the gold coins 24! grains per dollar, the ratio of 15 
to I being thus established. It was soon found, however, that 
gold was worth in the market slightly more than fifteen times as 
much silver, and as a consequence but little gold was brought 
to the mint for coinage, while such gold as was coined illustrated 
Gresham's law by speedily disappearing from circulation. 

Silver dollars, too, disappeared from circulation, but for another reason. 
They were somewhat lighter than the Spanish dollars which were in general 
circulation at the time, and would, under the operations of Gresham's law, 
have driven the latter out of circulation, had it not been that the Spanish 
dollar commanded a slight premium over the American dollar in ordinary 
purchases. But the American dollars, on account of their new and attractive 
appearance, could be used as advantageously as the Spanish dollars in trade 
with the Spanish possessions in America. They were consequently taken 
from the country for that purpose, while Spanish dollars were brought back 
and were sometimes recoined into a larger number of American dollars. 
This wasteful coinage of silver dollars was stopped in 1806 by order of 
President Jefferson, leaving the mint open to the coinage only of gold, smaller 
silver coins, and minor coins. As a matter of fact American coins made up 
only an insignificant part of our circulating medium before 1834. 

Realizing the impossibility of maintaining a gold coinage under 
such conditions, Congress, in 1834, changed the legal ratio to 
16 to I by reducing the weight of the gold dollar. By this step, 
however, it went too far in the other direction, for gold was not 
worth in the market quite sixteen times as much as silver, and 
while the number of gold coins increased, but little silver was 
brought to the mint, and silver coins quickly disappeared from 
circulation. In order to secure a supply of small change. Con- 
gress was forced, in 1853, to abandon the principle of the un- 

1 The act of 1792 followed in detail the recommendations of a Report on the 
Establishment of a Mint, by Alexander Hamilton, then Secretary of the Treasury. 
Hamilton incorporated some of the recommendations contained in earlier reports 
by Robert Morris and Thomas Jefferson. Hamilton's Report has been frequently 
reprinted, but it, together with the reports of Morris and Jefferson and other perti- 
nent documents, may be conveniently found in the Report of the International 
Monetary Conference of 1S7S. 



MONEY 265 

limited coinage of silver coins smaller than a dollar, and to order 
that they should be coined, as at present,, only from bullion 
purchased by the government at the market price. At the same 
time the weight of these subsidiary coins was reduced by one 
seventh to insure their being retained in circulation. 

The discovery of gold in California, in 1848, and in Australia, 
in 1 85 1, suddenly increased the world's supply of gold by an 
unprecedented amount. In fact, the careful estimates of Dr. 
Soetbeer indicate that as much gold was produced in the third 
quarter of the nineteenth century as in the preceding three cen- 
turies and a half following the discovery of America. The result 
was to increase the discrepancy between the mint ratio and the 
actual market ratio of exchange of gold and silver, although the 
production of silver had also been greatly increased. Gold was 
brought to the mint for coinage in enormous amounts — a con- 
dition that lasted even after 1861, when paper currency began to 
be used almost exclusively as the medium of exchange. 

In a general revision of the coinage laws, enacted in 1873, the 
silver dollar was dropped from the list of coins that could be 
manufactured at the mint. Although this action was almost un- 
noticed at the time, a fictitious significance has, in subsequent 
years, been attached to it. Silver was practically " demone- 
tized," that is, its free and unlimited coinage was actually pre- 
vented, by the establishment of the ratio of 16 to i in 1834. The 
act of 1870 gave legal recognition to an existing fact. 

But a sudden depreciation in the value of silver, which began 
at about this time, brought the question of bimetallism again 
into the foreground. Since the seventeenth century the market 
ratios of gold and silver had fluctuated only between relatively 
narrow margins, and in no year since the establishment of the 
United States mint had the average annual price of an ounce of 
gold been less than 15 or more than 16 j times the price of an 
ounce of silver. In 1875, however, the market ratio fell to 16 
to I ; by 1878 it was 18 to i ; by 1886 it was 20.8 to i ; and in 
1894 it was 32.6 to i.^ It is evident that if the opportunity for 

1 The causes of this unprecedented decHne in the relative value of one of the 
precious metals were complex and intricate. The following may be mentioned. 



266 OUTLINES OF ECONOMICS 

the free and unlimited coinage of silver at the ratio of i6 to i 
had still existed, there would have been another sudden change 
in the actual monetary standard. Gold would have been under- 
appraised by that ratio, and would have disappeared from cir- 
culation, and silver would have taken its place. It was the 
realization of this fact, coupled with the knowledge that the 
silver standard would mean a " cheaper dollar," that led to a pop- 
ular agitation for the free and unlimited coinage of silver which 
continued for more than twenty years. 

The first tangible result of this agitation was a compromise 
measure, the Bland-Allison Act, passed by Congress in 1878, 
which instituted the limited coinage of silver dollars by authoriz- 
ing the Secretary of the Treasury to purchase at market prices 
not less than $2,000,000 nor more than $4,000,000 worth of silver 
bullion per month, and to coin it into dollars. The results of 
this enforced coinage were satisfactory to neither party to the 
controversy. The amount of silver coined was in excess of the 
demand for that bulky kind of money, even though as much as 
possible was put into circulation in the form of silver certificates, 
and although the government tried to favor the distribution of 
silver by paying the expense of transporting it to the localities 
where it was wanted. The movement in favor of the unlimited 
coinage of silver continued to gain in strength, however, its ad- 
vocates claiming that " more silver," rather than less, was 
needed. 

A second compromise was effected in the Sherman Silver-Pur- 
chase Act of 1890, which provided for an increase in the amount 
of silver purchased to 4,500,000 ounces each month, which was 
to be paid for in treasury notes. These treasury notes were 
to be full legal tender, and were redeemable in gold or silver coin 
at the discretion of the Secretary of the Treasury. The silver 
was to be coined only so rapidly as was found necessary for the 
redemption of the treasury notes. The increase in the amount 

however, as contributing circumstances: (i) Cessation of an extraordinary de- 
mand for silver in India which had existed since 1850; (2) Stoppage of the unlim- 
ited coinage of silver in several European countries ; (3) Discovery of large silver 
mines in the United States; (4) Increase in the value of gold, as evidenced by a 
general decrease in the prices of commodities. 



MONEY 267 

of silver purchased was a concession to the advocates of the un- 
limited coinage of silver ; the fact that the circulating medium 
based immediately on these purchases was composed of treasury- 
notes, which were injected into circulation in proportion to the 
market price of the silver purchased, was a concession to their 
opponents. 

The Roundness of the principles embodied in the Sherman Act 
was soon tested by a period of financial and industrial depression. 
Gold had to be exported to Europe in large quantities to settle an ' 
adverse balance of trade, and the government found difficulty in 
maintaining its own gold reserve, which was already seriously 
threatened by a decline in customs receipts, accompanied by an 
increase in federal expenditures. The gold reserve was at that 
time simply the amount of gold in the treasury that was available 
for the redemption of other forms of money, — especially the 
United States notes, or greenbacks, that had been first issued 
during the Civil War, but which did not become actually redeem- 
able in gold until 1879. During this scarcity of gold the banks 
were able to secure gold for their own reserves or for export by 
presenting United States notes at the treasury for redemption 
in gold. Under the law the notes had tO' be immediately reis- 
sued, and were used in government payments, but no sooner 
was this done than they were again returned by the banks for 
redemption in gold. 

The workings of this " endless chain " by which gold was 
pumped from the government treasury were aggravated by the 
fact that the treasury notes authorized by the Sherman Act were 
used for the same purpose. Although they were payable either 
in gold or silver coin, they were actually redeemed on demand 
in gold. This was at the urgent insistence of President Cleve- 
land, who believed, with good reason, that a refusal to redeem 
them in gold would probably have forced the silver standard 
upon us, by destroying the exchangeability of silver and gold 
and thus putting an end to their parity, and that it would cer- 
tainly have injured the credit of the government and put it to 
a disadvantage in the bond sales that were needed to replenish 
the gold reserve. Under the operations of the Sherman Act 



268 OUTLINES OF ECONOMICS 

the government was virtually exchanging gold coin for silver 
bullion at a time when gold was sorely needed when the gold 
value of the purchased silver was steadily depreciating. 

The gold reserve sank from $190,000,000 in 1890 to $95,000,000 
in 1893. In June of the latter year the closing of the mints of 
India to the unlimited coinage of silver gave an added impetus 
to the downward movement of the price of that metal. These 
facts led Congress, in a special session called in 1893 ^OJ" that 
purpose, to order, though with obvious reluctance, that the pur- 
chase of silver under the Sherman Act should be stopped. 

The agitation for the free and unlimited coinage of silver continued, 
however, and with increased vigor, and it was made the sole issue in the 
presidential campaign of 1896. It was alleged that the yet continuing indus- 
trial depression could be alleviated only by "more money" and "cheaper 
money." It was claimed by many intelligent people that the unlimited 
coinage of silver would not drive gold from circulation, but would increase 
the value of silver and decrease the value of gold until they met at a parity 
established by the desired legal ratio of 16 to i. The most effective argu- 
ment of the protagonists of silver was found, however, in the admitted fact 
that the value of gold, as shown by changes in the general price level, had 
been increasing. AU indications pointed toward a continued decrease in 
the annual production of gold, and a consequent further decrease in prices. 
This, it was argued, was a hardship to those who had borrowed money on 
long time obligations, such as mortgages, because they would be forced to 
repay in value or purchasing power more than they had borrowed.^ 

This agitation was, in fact, simply one of a series of cheap money move- 
ments that have characterized the economic development of the United 
States, and which have sprung from the fact that the opening up and develop- 
ing of new lands have called for expenditures in amounts far beyond the 
resources of the actual settlers. Newly settled regions have usually been 
debtor regions, and there is more than mere coincidence in the fact that de- 
mands for cheap money have always been voiced most loudly on the frontier.^ 
This does not mean that a cheap money movement is essentially dishonest ; 
that it represents the conscious attempts of debtors to escape the payment 
of their lawful debts. The life and vigor in this movement for the unlimited 
coinage of silver was put into it by men who saw the imputed value of their 
assets sinking and the difficulty of paying their debts increasing in a financial 
crisis for which they were not individually responsible. Money funds were 

* This argument raises the problem of the standard of deferred payments, which 
is to be considered in Chapter XVI. 

2 Cf . C. J. Bullock, Essays in the Monetary History of the United States, Part i. 



MONEY 269 

hard to get because personal credit, the foundation of bank credit, was 
lacking. This scarcity of money funds was confused, naturally, if erro- 
neously, with the scarcity of "money" in the sense of standard money, — 
gold; and the remedy was sought in an action that would give more and 
cheaper standard money. 

The defeat of the advocates of bimetallism in 1896 would probably not 
have stopped the agitation for the unlimited coinage of silver, had it not been 
for the return of prosperous conditions, coupled with an enormous increase 
in the world's annual production of gold, which has brought with it a general 
increase in prices. 

The single gold standard was formally and definitely recog- 
nized by law in 1900. All of the silver bullion purchased under 
the Sherman Act has been coined, and silver dollars sufficient in 
amount to retire the treasury notes have been set aside for that 
purpose. These treasury notes (which should not be confused 
with the United States notes, or greenbacks) are accordingly on 
substantially the same basis as silver certificates. Up to June 
30, 1915, their amount had been reduced from $156,000,000 to 
$2,250,000. No silver dollars have been coined since 1904, and 
under the present law no more can be coined unless Congress 
should authorize the special purchase of bullion for that purpose. 

The Gold-Exchange Standard. — Within the past twenty 
. years gold has been accepted more generally and more definitely 
than ever before as the standard money metal of the world. The 
change from a silver standard to the gold standard is often a 
difficult and expensive national undertaking, but it brings the 
advantages of a more stable unit of value and of increased 
facility in making international payments. In 191 5 the silver 
standard prevailed only in China, Persia, Paraguay, and three 
Central American countries.^ 

In a number of places in which it is impossible, for one reason 
or another, to introduce gold as part of the actual medium of 
exchange, the silver standard has been replaced by the gold- 
exchange standard. Where this standard exists the currency 
of the country consists largely of silver coins, put into circula- 
tion by a system of limited coinage. These coins are maintained 
at a fairly definite gold value, higher than that of their bullion 

1 Report of the Director of the Mint, in Finance Report, 1915, p. 456. 



270 OUTLINES OF ECONOMICS 

content. This is not accomplished, however, by making them 
always and necessarily redeemable in fixed quantities of gold. 
Instead the government agrees to sell exchange on one or more 
gold-using countries at a maximum fixed price in terms of the 
local coins. ^ That is, while the local currency is not necessarily 
redeemable in gold within the home country, it is redeemable 
in bills of exchange or drafts payable in gold in some foreign 
country. It is necessary, of course, for the home government 
to maintain funds for this purpose in a gold-using country.- The 
gold-exchange standard has been adopted in India, the Philip- 
pines, Mexico, Panama, Siam, Indo-China, the Straits Settle- 
ments, and (in a modified form) in Java. 

Where carefully administered it has worked well, and has 
brought to the countries using it practically all of the advantages 
of the gold standard without the expense of introducing and 
maintaining a gold currency and sometimes without making 
it necessary for the people to familiarize themselves with a new 
kind of money. It has even been suggested by certain writers 
that the great nations of the world might wisely adopt the gold- 
exchange standard, making their local currencies redeemable 
at fixed rates in drafts upon some one country in which the bulk 
of the gold reserves of the world would be kept A change like 
this is impracticable so long as wars, with their interruptions of 
international commerce and international gold payments, re- 
main possible. Nor would it be particularly advantageous. 
The general adoption of the gold-exchange standard would, it 
is true, greatly decrease the amount of gold needed to carry on 
the world's business transactions at present prices. But the ul- 
timate result, there is good reason to believe, would merely be a 



1 Since 1893 the mints of India have been closed to the free coinage of silver. 
Silver rupees, coined from bullion purchased by the government, are now main- 
tained at a gold value of approximately one shilling and four pence per rupee by 
the government's practice of selling, when necessary, bills of exchange payable in 
London at a price not higher than \s. 3?| d. per rupee. The peso of the Philippines, 
containing only about three fourths as much silver as the silver dollar of the United 
States, is maintained at a gold value of approximately fifty cents by the insular 
government's accepting it at that price (minus a small charge) in exchange for drafts 
payable in New York. 



MONEY 271 

general increase in prices, so that the aggregate volume of pay- 
ments (measured in money units) would increase and more 
gold would be needed in the world's gold reserves. The world 
as a whole does not profit by " economizing in the use of gold," 
even though particular countries may be able to save by avoid- 
ing the expense of introducing a gold currency. 

Government Paper Money. — In metallic money of limited 
coinage, there is, as we have seen, a considerable element of 
credit. In paper money the element of credit is alone present. 
Government paper money is composed of instruments which bind 
the government to pay, and usually to pay on demand, equiv- 
alent amounts of metallic money, — usually standard money. 

Government paper money also differs from metallic money of 
limited coinage in respect to the motives which gives rise to and 
regulate its issue. Subsidiary coins are issued by the govern- 
ment in response to the demand for circulating medium for use 
in small transactions and in making change. The public con- 
venience is the first consideration ; the profit accruing to the 
government on such coinage is a secondary thing. In issuing 
government paper money, however, fiscal motives have predomi- 
nated. When hard pressed to swell the government income to 
cover an increase in expenditures, those responsible for the finan- 
cial policies of a government have often deemed it advisable for 
the government to make use of its own notes, promises to pay, 
in discharging its obligations. 

These differ from government bonds, which are often issued in 
similar circumstances, in that the bonds bear interest, are sold to 
voluntary buyers, and are usually payable at a definite time in 
the future, while government notes are usually non-interest 
bearing, represent a forced rather than a voluntary loan, and are 
usually, in form at least, payable on demand, or in practice, at an 
indefinite t-ime in the future. They are, moreover, issued in 
convenient form for monetary use, and are usually made legal 
tender, so that they pass from hand to hand as a medium of ex- 
change. The forced loan which they represent is therefore 
shifted from those who first receive the notes from the govern- 
ment for their goods or their services. 



272 OUTLINES OF ECONOMICS 

Colonial and Revolutionary Bills of Credit. — Paper money 
issues have frequently been used in the United States as a means 
of meeting fiscal emergencies, especially those springing from the 
extraordinary expenditures occasioned by wars. The expense of 
sending trodps to the Indian wars was one of the things that led 
most of the American colonies to issue paper money. The his- 
tory of these colonial " bills of credit," as they were called, illus- 
trates two dangers that seem to be inseparable from the use of this 
financial and monetary device. In the first place, it was very 
easy to succumb to the temptation of paying ordinary as well as 
extraordinary expenditures in this easy way. Some of the colo- 
nies got entirely out of the habit of taxing themselves to meet 
current public expenses. The refusal to levy taxes was a prolific 
cause of disputes between colonial assemblies and royal gov- 
ernors. 

In the second place, because no money was raised for the pur- 
pose, these bills of credit were not redeemed promptly. Their 
purchasing power fell because people lost confidence in their 
redeemability. As prices rose it took continually larger issues 
to meet the government expenditures, and each increase in the 
amount in circulation led to a further fall in purchasing power. 
After the currency had become practically worthless, it was a 
common practice to repudiate it in whole or in part, and to start 
afresh with bills of a " new tenor." Any attempt to restrict 
this reckless use of public credit was met with determined resist- 
ance from the " cheap money " advocates of that day. There 
were frequent complaints of the scarcity of money, especially 
from the more newly settled districts. The greater the quantity 
of money issued, the more insistent was the demand for still 
further issues. In short, this colonial experience in itself gives 
sufficient basis for the inference that from the monetary as well 
as the fiscal point of view, the use of paper money easily de- 
generates into a bad habit. 

Again, in the Revolutionary War, paper-money issues were 
made, — this time by the Continental Congress as well as by the 
individual colonies. The Continental Congress was really 
driven to this action by its lack of the power of levying taxes. 



MONEY 273 

Its bills became practically worthless, although every effort was 
made to maintain their parity with metallic money by appeals 
to patriotic sentiment. After the formation of the national 
government a few of them were redeemed at one cent on the 
dollar. 

It was our unfortunate colonial and revolutionary experience 
with paper money which led to the insertion of the wise provision 
in the federal Constitution which forbids the individual states to 
issue bills of credit or to made anything but gold and silver legal 
tender in payment of debts. 

The Greenbacks. — The federal government made no impor- 
tant issues of paper money until the Civil War.^ It was not 
generally foreseen that that conflict would be so long continued 
and intense as it was, and Congress consequently neglected to 
make adequate provision for taxes that would help to meet the 
increased expenditures and to sustain the government credit in 
the borrowing operations that were necessary. In 1861 the 
Secretary of the Treasury was authorized to issue at his discre- 
tion $50,000,000 in " demand notes," which, although they were 
not legal tender-, could be used in all payments to the government. 
These were redeemed promptly on demand until the end of the 
year, when the withdrawal of gold from the banks by depositors 
for hoarding, and by the government for its own uses, led first 
the banks and then the government to suspend specie payments, 
— that is, to refuse to pay their current obligations in gold. 

In February, 1862, moved by the absolute necessity of provid- 
ing some kind of money for the federal treasury. Congress 
authorized the issue of $150,000,000 in legal tender notes,^ or 
greenbacks, as they came to be called. It was hoped, moreover, 
that this increase in the circulating medium would improve the 
market for government bonds for which the greenbacks were at 
first made convertible at par. This action was not taken without 

* The federal government issued treasury notes in the war of 1812 and the Mexi- 
can War, and during the panics of 1837 and 1857. Most of these issues were interest 
bearing, however ; in no case were they legal tender, nor did they get into common 
use as media of exchange. 

2 Including the "demand notes," which were now made legal tender. 
T 



274 OUTLINES OF ECONOMICS 

strenuous opposition on the part of those who foresaw some of 
the disastrous consequences of large paper money issues. But 
as in earHer American experience with paper money, succeeding 
issues met with less and less resistance. All together, green- 
backs to the amount of $450,000,000 were issued during the war. 

It was the general expectation when the greenbacks were is- 
sued that they would lie retired as soon as possible after the con- 
clusion of the war. But when such action became possible, it 
was opposed by many who thought that the reduction of the cir- 
culating medium would decrease prices, impose additional bur- 
dens upon debtors, injure business interests, reduce the public 
revenues, and hamper the government in the refunding of its 
public debt. In 1866, however, Congress authorized the gradual 
retirement of the greenbacks, but repealed the act in 1868. The 
amount in circulation in 1874 was $282,000,000, and in that year 
a bill requiring the definite increase of the issue to $400,000,000 
was prevented from becoming law and thus establishing a 
dangerous precedent only by the veto of President Grant. 
Some greenbacks were retired under the provisions of an act of 
1875, but in May, 1878, there were $346,681,000 outstanding, 
and as a law then enacted provides for their constant reissue 
after being received or redeemed at the treasury, the amount 
still stands at that figure.^ The part that they played in the 
financial difficulties of 1 890-1 893, together with the history of the 
treasury notes of i8go, has been described in connection with 
the discussion of bimetallism. 

At present the greenbacks constitute a useful arid acceptable 
part of the stock of money. But if another financial crisis should 
deplete the government treasury, they would very likely prove 
again to be a source of difficulty. Their retirement is feasible 
under present conditions, but would be most difficult to accom- 
plish under the very financial conditions under which they would 
be most dangerous. The currency act of 1900 provides for a 
gold reserve of $150,000,000, to be held against them to insure 
their redeemability. If the reserve falls below $100,000,000, 
the Secretary of the Treasury is directed to replenish it from the 

* Since 1900 they have been reissued only in exchange for gold. 



MONEY 275 

proceeds of bond sales. Although this gold reserve also con- 
stitutes part of the real security behind our silver dollars, it could 
safely be diminished in amount if the greenbacks were retired. 
Moreover, if a great national emergency should ever again 
make the issue of government paper money necessary, it would 
be highly advantageous to have the greenbacks out of the way.« 

Economic Effects of the Greenbacks. — The greenbacks are in 
form promises to pay, but they are not promises to pay on de- 
mand, nor at any specific time. During the period of the sus- 
pension of specie payments they were not actually redeemable 
in gold, nor was gold in general circulation as a medium of ex- 
change except on the Pacific coast. Gold was, however, in addi- 
tion to its industrial uses, employed as money in international 
trade, in the payment of interest on government bonds, and for 
customs duties (for which the greenbacks were not legally re- 
ceivable). There was thus a constant demand for gold money, 
which was met by its sale as a commodity in the New York mar- 
ket. The gold market was highly speculative, the daily and 
even the hourly fluctuations in the price of gold in greenbacks 
being considerable. Notwithstanding these speculative features 
the prices paid for gold indicated very accurately, in the long run, 
how much, in the expert judgment of market specialists, the 
greenbacks should be discounted as compared with gold. 

Everything that was thought to affect the probability of the 
ultimate redemption of the greenbacks in gold influenced their 
price. Among these factors were the quantity of greenbacks 
issued, the condition of the federal treasury, the military suc- 
cesses and reverses of the Union cause, and, in later years, the 
prospects for the resumption of specie payments. Greenbacks 
reached a parity with gold two weeks before the resumption of 
specie payments on January i, 1879. A fact of special sigriifi- 
cance is that until July, 1863, the greenbacks were convertible 
at par into 6 per cent gold bonds. These bonds formed an ac- 
tual standard of value for the greenbacks, and although them- 
selves depreciated, exercised for the time being a steadying 
influence upon their price. 

As the common medium of exchange consisted almost entirely 



276 OUTLINES OF ECONOMICS 

of greenbacks ^ and of bank notes convertible only into green- 
backs, prices were stated in greenback " dollars " and naturally- 
rose as the gold value of the greenback depreciated. Reference 
to the table on the next page will show a rough correspondence 
between changes in the general level of prices, expressed in green- 
*backs, and changes in the price of gold, also expressed in green- 
backs. But the wholesale prices of commodities rose relatively 
higher than did the price of gold, and declined less rapidly .^ 
Retail prices, in turn, declined less rapidly than did wholesale 
prices. Wages advanced more slowly than prices; maximum 
wages were not paid until 1872, — seven years after retail prices 
and eight years after wholesale prices had reached their maxi- 



That there was not a closer correspondence between the movement in gen- 
eral prices and the changes in the gold value of the greenback was due to two 
sets of influences : (i) Even if greenbacks had not been issued, and if prices 
had been expressed in gold, there would have been marked fluctuations in 
prices, — not only such as continually occur in normal years, but also those 
due to such exceptional things as the withdrawal of a large number of men 
from industry and agriculture to military service, the shifting of productive 
effort in response to the enormous demand for military supplies, the period 
of extraordinary business activity, of railway building, and of agricultural 
and industrial expansion that followed the war, the reaction and financial 
crisis in 1873, and the return of prosperous conditions in the last years of the 
greenback period.' (2) The depreciation in the gold value of the greenback 
was recorded quickly and accurately in the gold market, but the movement 
of prices was hampered by habit, custom, existing contracts, local influences, 
etc. Retail prices are less sensitive to changing market conditions than are 
wholesale prices. Wages, in turn, are usually less mobile than retail prices. 

1 Subsidiary coins did not go out of circulation until 1862, when the value of 
the greenback dropped below the value of the bullion in these coins. Postage stamps 
and notes and tokens issued by cities and by business firms were for a while used 
as small change. In 1862 the situation was helped by the issue of fractional paper 
currency in denominations as low as three cents. 

2 The more detailed figures, of which the table given here is only a summary, 
show that the prices of commodities also advanced more slowly than did the price 
of gold. For an illuminating discussion of these price changes see Mitchell, Gold, 
Prices, and Wages under the Greenback Standard, Chap. v. 

' This statement is subject to the limitation implied in the fact that general 
commercial conditions were themselves caused in part by the influence of the cheap 
and fluctuating medium of exchange. 



MONEY ^ 277 

TABLE I 
Prices and Wages in the Greenback Period 1 



Year 


Average 

Annual Price 

OF Gold in 


JtTLY 

Wholesale 


Average Annual Prices' 


Average 
Wages < 




Greenbacks 


Prices ^ 


Wholesale 


Retail 


i860 


— 


100 


100 


100 


100 


1861 


— 


95 


94 


107 


99 


1862 


^^3-3 


120 


109 


131 


104 


1863 , 


145.2 


155 


148 


168 


119 


1864 


203.3 


236 


225 


215 


142 


1865 


157-3 


183 


224 


219 


iSS 


1866 


140.9 


191 


203 


208 


164 


1867 


138.2 


170 


177 


193 


167 


1868 


139-7 


165 


180 


190 


170 


1869 


133-0 


158 


172 


177 


179 


1870 


114.9 


145 


156 


166 


179 


1871 


111.7 


137 


144 


155 


184 


1872 


112.4 


139 


138 


151 


1854/ 


1873 


113.8 


140 


143 


148 


183 


1874 


III. 2 


138 


144 


145 


17s 


187s 


1 14.9 


129 


134 


140 


163 


1876 


iii.S 


118 


120 


^3S 


153 


1877 


104.8 


114 


117 


134 


143 


1878 


100.8 


99 


99 


127 


142 


1879 


100.0/ 


98 


93 


123 


139 



All these things interacted. Wages, to give only one example, constitute an 
important part of the expenses of producing commodities, and the sluggish 
movement of wages kept the expenses of production from advancing, and 
later from falling, as rapidly as would otherwise have been the case, and 
must have had a corresponding effect on the prices charged for commodities. 

Aside from these general changes, the minor fluctuations, the 
short-time variations in prices, were unusually wide and numer- 

1 Compiled from Gold, Prices, and Wages under the Greenback Standard, by Wesley 
C. Mitchell. The figures in the price columns are obtained by counting the price 
of each commodity in each year as a percentage of its price in i860, and then averag- 
ing the various relative prices thus obtained for each year. The figures in the wage 
column are computed in a similar way. In the "price of gold" column parity be- 
tween greenbacks and gold is represented by 100. 

2 g2 commodities. ^ 21 commodities. ^ For 78 establishments. 



278 OUTLINES OF ECONOMICS 

ous, — a fact which may be attributed to the uncertain future 
of the medium of exchange. Such fluctuations were apt to up- 
set all business calculations ; chance became more important and 
foresight less important as a factor in profits. Under such condi- 
tions an intense and reckless spirit of speculation was bred, with 
unfortunate effects on business morality as well as on economic 
conditions. 

As a fiscal expedient, the greenbacks led to results as disastrous 
as those which attended their use as money. The government 
was forced to sell bonds for depreciated greenbacks, but in order 
to maintain its credit it had to pay the interest and ultimately 
the principal of these bonds in gold. Supplies for the army were 
paid for in depreciated greenbacks, but these greenbacks had to 
be ultimately redeemed in gold. It has been estimated that 
the use of the greenbacks increased the expense of the Civil War 
by nearly $600,000,000.^ 

Fiat Money, — After 1873 the advocates of cheap money were 
not content with merely opposing any reduction in the quantity 
of the greenbacks. They went so far as to urge that the amount 
of paper should be greatly increased, and that the use of metallic 
money should be definitely and permanently abandoned. Bank 
notes were also attacked because they were issued by " privileged 
corporations." The question came to be an irnportant political 
issue, and in 1876 it brought about the organization of the Green- 
back party, which figured in three presidential campaigns, 
and which polled more than a million votes in the congressional 
elections of 1878. In more recent years similar demands were 
voiced by the Populist party. ' 

The theory of money which formed the basis of the contention 
of the members of the Greenback party is sometimes called the 
*' fiat money " theory. Those who held this theory of money 
saw no significance in the fact that the greenbacks were in form 
promises to pay and that they were generally regarded as only 

1 This estimate applies only to the increased expense to the government, and conse- 
quently to its taxpayers. The real economic costs of the war were not greatly 
affected by the use of the greenbacks. Bondholders gained, for example, a large 
part of what taxpayers lost. 



MONEY 279 

temporarily irredeemable. In their view they were simply 
" dollars," made such by the expressed will of the government. 
Nor did they see any significance in the fact that during the 
seventeen years of the suspension of specie payments over 
$500,000,000 in United States gold coins issued from the mints. 
As a matter of fact the fiat money advocates were misled by what 
some logicians have called the " jingle fallacy." That the 
" dollar " of the ordinary medium of exchange and the " dollar " 
as a standard monetary unit were different things did not occur 
to them. 

If they had succeeded in eliminating the credit element in the 
paper currency by ceasing to print " promises to pay "(as they 
actually proposed to do), and had instituted a new name for the 
money unit, — possibly (to reverse the spelling )" rallod," — 
they would perhaps have encountered difficulty in getting people 
to use pieces of printed paper, informing them that " This is a 
rallodj" as money. It is hard to see how " the supply of money 
as compared with the demand for it," on which the fiat money 
advocates counted to fix the purchasing power of their money 
units, would have helped matters very much. Nor would the 
redeemability of fiat money in interest-bearing bonds, which was 
suggested by some, have given us a monetary standard. For the 
bonds would have been merely promises to pay certain sums of 
fiat money, with interest at a certain rate, also in fiat money. 
The difficulties that would have been encountered in international 
trade would alone have sufficed to make fiat money impossible. 

This should not be taken to mean, however, that irredeemable 
paper money, issued in familiar denominations, may not under 
favorable circumstances circulate for some time among people 
accustomed to its use, even if there is no prospect of its ever 
being redeemed. The most important of the necessary " favor- 
able circumstances " is the absence of complications in foreign 
trade, such as have already been discussed in connection with" 
the subject of seigniorage. But, at best, there would be a host 
of practical difficulties in the way of getting the right amount 
of money, and only the right amount, into circulation. 



28o OUTLINES OF ECONOMICS 

QUESTIONS 

1. Would wheat make a satisfactory money commodity? iron? plati- 
num ? diamonds ? 

2. Would it be possible to maintain a seigniorage of lo per cent on United 
States gold coinage? What would be the effect on the prices of imported 
commodities? of domestic commodities? 

3. Report on the following questions not answered in this chapter : 
(i) What is the "limit of tolerance" ? (2) On whom does the loss from the 
wear of gold coin fall? (3) To what extent are different kinds of United 
States money legal tender ? 

4. If the United States had adopted the free and unlimited coinage of 
silver in 1896, how would prices have been affected? 

5. Is the actual monetary standard pure gold or gold of standard fineness ? 

6. What elements of truth are there in the statement that "coins get 
their value from the government stamp"? 

7. In the table printed on page 254, why are not gold certificates, silver 
certificates, and treasury notes of 1890 included in the statement of the 
aggregate amount of money in the United States? 

8. Interpret the statement : "The value of the greenbacks depreciated." 
Explain in particular the meaning of the words value and depreciated as thus 
used. 

9. Do you make a loan to the government when you receive greenbacks 
in payment for goods or services ? 

REFERENCES 

Bullock, C. J. Essays in the Monetary History of the United States. 
Commission on International Exchange (1904). Report on the Introduction 

of the Gold Exchange Standard. 
Dewey, D. R. Financial History of the United States. (See index.) 
Director of the Mint. Annual Report. 

DoDD, A. F. History of Money in Great Britain and America, 
Hepburn, A. B. History of American Currency. 
Huntington, A. T., and Mawhinney, R. J. (Compilers). Laws of the 

United States Concerning Money, Banking, and Loans, lyjS-igog. 
Jevons, W. S. Money and the Mechanism of Exchange. 
Johnson, J. F. Money and Currency. 
Kinley, David. Money. 
Knox, J. J. United States Notes. 
Laughlin, J. L. History of Bimetallism in the United States; The Principles 

of Money. 
Mitchell, W. C. History of the Greenbacks ; Gold, Prices, and Wages 

under the Greenback Standard. 
Scott, W. A. Money and Banking, Chaps, i-vi, xiv, xv. 



MONEY 281 

Taussig, F. W. Principles of Economics, Vol. i, Chaps, xvii-xxiii. 

Treasurer of the United States. Annual Report. (This, together with ab- 
breviated forms of the reports of the Director of the Mint and the 
Comptroller of the Currency, is printed as an appendix to the Report 
of the Secretary of the Treasury in the bound edition of the annual 
Finance Report.) 

Walker, F. A. Money; Money in its Relation to Trade and Industry. 

Watson, D. K. History of American Coinage. 

White, Horace. Money and Banking. 



CHAPTER XV 
CREDIT AND BANKING 

Credit Transactions. — Thus far, in our discussion of money, 
we have failed to take account of the fact that the greater part 
of exchanges are credit transactions, which do not directly or 
immediately involve the use of money (in the sense of generally 
acceptable money instruments). A credit transaction is a 
transfer of goods, services, or money for a future equivalent. 
In a " cash" transaction there are only two elements,- — the 
goods sold and the money paid for them. But in a credit trans- 
action a third element — time — is added. The introduction 
of this third element leads to exceedingly important results. 
In the first place it makes possible an enormous number of ex- 
changes in which the buyer is either unable or disinclined to ren- 
der a present equivalent. In the second place it obviates, to a 
very large extent, the necessity of using money. 

Suppose, for example, that A and B are the only inhabitants of 
an isolated community. Three ways of making exchanges are 
open to them. They can use a system of direct exchange or 
barter, which will prevent A from getting goods from B unless he 
has some equivalent which he is willing to give up and which B 
is willing to accept. Or, they may use one commodity as money, 
in which case the purchasing power of either A or B at any given 
time will be governed by the amount of that particular commod- 
ity he possesses, rather than by the total amount of all his posses- 
sions. But by combining a system of credit with their use of 
money, they will be able to make transfers freely, for in an occa- 
sional balancing of accounts most of the payments due each other 
will cancel, leaving only a relatively small amount to be paid in 
money. 

282 



CREDIT AND BANKING 283 

Something very much like this third process is continually 
going on in contemporary economic life. The process is more 
complex, however, because A actually sells things to one person 
or group of persons, and buys them from other persons. And it 
is very likely that these two groups, the sellers and the buyers 
in A's transactions, have no direct business transactions with 
each other in which their respective claims against A and debts 
to A can be canceled. If, however, we take all buyers and all 
sellers into account, and if we could push our analysis of the com- 
plex network of credit relations far enough, we would find points 
of contact between A's credits and his debts. That is, if A gives 
a promissory note in exchange for a purchased good, this promis- 
sory note might be passed on from hand to hand until it got into 
the possession of someone who is indebted to A, — if the path it 
should take were known. The difficulty is that the path is not 
known. The institution of banking, however, provides clearing 
centers, where credits and debts are balanced against each other 
and canceled. 

A, for example, has a " deposit " in a local bank, which means 
that he has the right to demand money from it at any time up to 
the amount of his deposit. He usually makes a payment to B, 
not by money or by a promissory note, but by a check, — an 
instrument ordering the bank to pay B the specified amount. 
This check will be presented for payment by B at a bank where he 
has a deposit, but the "payment " will usually be made by add- 
ing the amount of the check to B's deposit. If it is the bank 
where A also has his deposit, the transaction is settled by the 
simple process of debiting A's deposit and crediting B's. If 
it is another bank in the same town, and if the town is a small one, 
the check will enter into the daily exchange by the two banks 
of such claims against each other, the daily balance in favor of 
either bank being usually settled in money. 

In the larger cities a further economy in the use of money is 
achieved by means of the clearing house, to which a representa- 
tive of each bank brings daily all of the checks drawn against 
other local banks which it has received since the last " clearing." 
At the clearing house the checks are turned over to the repre- 



284 OUTLINES OF ECONOMICS 

sentatives of the banks against which they are drawn, but bal- 
ances are not settled between the individual banks. Instead, 
a balance is struck between the total sum of each bank's claims 
against other banks and the total claims of other banks against 
it. Each bank then pays to the clearing house, usually in money, 
or receives from it, as the case may be, the amount of balance 
due to it or from it. This system achieves a great economy of 
both time and money.i 

If the banks in which A and B keep their deposits are in differ- 
ent towns, A's check will probably be sent by B's bank to a bank 
in a neighboring large city, in which B's bank has its own deposit 
account. If A's bank is also in the territory tributary to this 
same city, the check may be sent by the city bank directly to 
A's bank for collection, or to its own correspondent bank in the 
same town. If A's bank is in another part of the country, the 
check will be sent to a bank located in a large city in that region, 
which will attend to its collection.^ Thus a check drawn on a 
local bank in California, deposited in a local bank in Illinois, will 
very likely be collected via Chicago and San Francisco. The 
balances of credits and debits which are thus created between 
city and country banks are settled to a very large extent by 
means of crediting and debiting deposit accounts in city banks, 
thus obviating by that much the necessity for frequent shipments 



1 Over $90,840,000,000 in checks and drafts passed through the New York Clearing 
House in the year ending September 30, 1915. The money balances paid amounted 
to $5,340,000,000, or less than 6 per cent of the total clearings. The average cash 
payments required during the last sixty -two years have amounted to less than 5 per 
cent of the clearings. In times of financial stringency clearing houses sometimes 
permit payment of balances in "clearing house loan certificates," issued to individual 
banks upon the basis of approved securities deposited with the clearing house. In 
some cases the banks have temporarily put such certificates into general circulation 
as emergency currency. 

2 The London Clearing House clears for all England in a very simple and efficient 
way. A country bank sends its daily receipts of checks on banks in other towns 
to the London bank in which it keeps a deposit. In a daily "country clearing" 
these checks are distributed to the London banks where the banks on wliich the 
checks are drawn keep accounts. The mere territorial extent of the United States 
makes such a scheme unworkable here. The federal reserve banks, however, 
hope to develop a system of regional and inter-regional clearings for their member 
banks. 



CREDIT AND BANKING 285 

of money. In general, we have in the United States a continuous 
balancing and cancellation of debts and credits, first, in each 
locality ; second, between each important city and its tributary 
territory, and, third, between the different important cities. 
Much the same process is characteristic of international exchange, 
but that is a topic which will be treated in another chapter. 

Personal Credit. — If a man does not hoard money on the one 
hand, or fail to pay his debts on the other hand, his expenditures 
(including investments) are bound to be, in the long run, approxi- 
mately equal to his income. But for a business man a continuous 
equality of income and expenditure is impossible. At some 
times his deposit account will be built up more rapidly than he 
checks it out ; at other times his need for means of making pay- 
ments will outrun his receipts. If, for example, he is a con- 
tractor, whose expenses of production are fairly constant, but 
whose product is paid for only when completed, or a merchant, 
who replenishes his stock of goods twice a year but whose sales 
are distributed throughout the year, or a farmer who must pay 
his harvest expenses before he sells his crops, he may find it nec- 
essary to utilize his credit. This he does by giving to others 
rights to demand money from him in the future. Now, the extent 
to which he can utilize his personal credit, his power of purchasing 
things without immediate money payment, will depend to some 
extent on his personal ability and integrity. But, nevertheless, 
the fundamental measure of his credit will be the amount of his 
realizable wealth. This, however, may consist in part of prop- 
erty that is not " for sale," — his stock of consumption goods 
and his income-yielding land or capital, and in part of things that 
he hopes to sell in the normal course of business. 

These things do not have to be sacrificed immediately in order 

\ to acquire the present means of payment. To meet a temporary 

V, need they may be made the basis of credit, through the process 

y-Nof hypothecation, a name which means the conditional transfer 

of property rights. The hypothecation may be definite and 

formal, as when a mortgage is given on specific items of property 

or when valuable credit instruments of various sorts (such as 

government or corporation bonds, bills of lading, warehouse 



286 OUTLINES OF ECONOMICS 

receipts, etc.) are put into the actual possession of the creditor 
as " collateral security " ; or it may be simply implied, as in 
the case of an " unsecured " personal note, for practically all of 
the property of a borrower, over and above the items specifi- 
cally hypothecated for certain debts is, in legal fact, hypothe- 
cated for his remaining debts. It is important to note, too, that 
future values, rather than present values, constitute the basis of 
present credit. The lender's interest is in the question of the 
adequacy of the money value of the security at the time when 
payment becomes due. Present prices being equal, a borrower 
can secure a larger amount of credit when market conditions are 
improving than when they are declining. 

A man's probable future income and the probable future 
money value of his property, then, constitute the real measure 
and foundation of his personal credit. His personal credit, 
however, is of limited use to him as a means of payment. Some 
difficulties in the way of using personal notes as media of ex- 
change have already been suggested.^ There is another diffi- 
culty in the fact that his personal notes will not be willingly 
accepted by others in lieu of money payments unless they know 
him, the value of his property, and the extent to which it is 
already hypothecated. Moreover, these same difficulties stand 
in the way of such notes being passed from hand to hand, even 
j with successive indorsements. 
. 1 Bank Credit. — In order to acquire a readily available medium 
of exchange, personal credit has to be exchanged for bank credit. 

1 It is true, of course, that business men often accept their customers' notes in 
payment of accounts, or as an equivalent for goods purchased. These notes, 
however, do not usually pass any farther as a medium of exchange, but are in- 
dorsed by the business man and presented to a bank for discount. Such notes, 
often known as "trade paper," constitute a large part of the securities of many 
commercial banks. In recent years, however, an increasing proportion of bank 
loans have been made upon "one-name paper." Buyers find it advantageous to 
secure the discounts for cash payments usually given by manufacturers, whole- 
salers, and jobbers, obtaining the necessary funds by borrowing from the banks 
on their own notes. The federal reserve banks are attempting to increase the use 
of paper bearing the names of both buyer and seller, and in particular to develop 
a larger use of bills of exchange (drafts) in place of promissory notes. The pur- 
pose is to make it easier to distinguish those borrowings which arise from " actual 
commercial transactions." 



CREDIT AND BANKING 287 

Instead of using his own note as a medium of exchange, a business 
man will normally have it " discounted " by his banker. If the 
note is for sixty days, for example, the business man yields the 
right to demand a specific amount of money from him in sixty days, 
in exchange for a deposit credit, — the right to receive on demand 
the same amount of money less the discount} The business man 
adds the note to his liabilities and the deposit to his assets. The 
bank adds the note to its assets and the deposit to its liabilities. 

Having exchanged his personal credit for a bank deposit, the 
business man can now use the latter as a means of payment 
through the checking system that has been described. Ordinary 
commercial banking consists, in large part, of this purchase of 
personal credit and sale of banking credit. The bank builds 
up assets in the form of loans and discounts at the same time that 
it builds up its obligations in the form of deposits. 

The security behind the deposit liabilities of any bank consists 
of: (i) loans and discounts, which in turn rest back upon per- 
sonal credit or upon specifically hypothecated property (as in 
the case of loans on collateral security) ; (2) bonds, mortgages, 
and other securities owned by the bank, which, if necessary, 
may be sold for the benefit of the depositors, unless specifically 
pledged as security for bank note issues ; (3) the bank's own de- 
posits in other banks, together with the checks or similar claims 
against other banks that are in its possession ; (4) its other 
property (building, fixtures, etc.) ; (5) (in national banks and 
some state banks) the personal liability of the bank's stock- 
holders ; 2 (6) its stock of money. 

1 Discount is simply one form of interest. Banker's discount differs from ordi- 
nary interest in that it is computed as a certain per cent of the total amount that 
is repaid, while ordinary interest is computed as a per cent of the amount that is 
lent. Discount is deducted from the principal of the loan in advance ; interest 
is paid at the maturity of the loan or (on long time loans) at stated intervals. On 
demand or "call" loans and on time loans on collateral security "interest" rather 
than "discount" is charged. 

2 Even in case some of the bank's loans or securities prove worthless there is a 
margin of safety for the depositors in the fact that some of the assets of the bank 
represent the original investments of the bank's stockholders {^^ capital") or profits 
which they have put back into the business {"surplus"), and on such assets the 
depositors have the first claim. Moreover, in national banks and some state banks 



288 OUTLINES OF ECONOMICS 

But that these assets should sufl&ce to cover the deposit Ka- 
bilities of a bank is not in itself sufficient to maintain its solvency. 
Much depends upon the character of the assets, — the amount 
of money included in them, and the ease and quickness with 
which other parts of the assets can be converted into money. 
Each deposit account is an obligation of the bank to pay in 
actual money if it is demanded. The depositor cannot use 
checks for all kinds of payments, but will often have to draw on 
his deposit account for money. Even when payments are 
made by checks, those who receive them will often prefer to cash 
them rather than to deposit them. Moreover, the process of the 
cancellation of credit obligations is, as we have seen, not alto- 
gether perfect. Balances arise between individual banks in the 
same city, between city and country, between different cities, 
and between different nations that very often have to be settled 
in money. 

Statement of the Condition of a National Bank in a Small Town 



Resources 



Liabilities 



Building and fixtures . 
Government bonds 
Other securities . . . 
Loans and discounts . 
Due from other banks 
Cash 



$4S,ooo 
50,000 
30,000 

460,000 
42,000 
3S,ooo 



Capital stock . . 
Surplus .... 
Notes outstanding 
Deposits .... 
Due to other banks 
Undivided profits . 



$ 50,000 
25,000 
48,000 \ 
531,000^ 
3,000 ^ 
5,000 --" 



Total resources 



$662,000 



Total liabilities 



$662,000 



A bank accordingly has to keep enough actual cash on hand to 
enable it to meet any demands that may be made upon it for 
money. As deposits constitute the most important cash obliga- 
tions of most banks, the size of this money reserve, as it is called, 
is normally fixed for safety's sake at a certain per cent of the 
amount of the deposits. This proportion varies according to 

the stockholders are in addition personally liable up to an amount equal to the 
par value of their holdings. 



CREDIT AND BANKING 289 

the location of a bank and the nature of its business. In prac- 
tice it varies in different commercial banks from as low as 5 per 
cent to as high as 35 per cent of the deposits. 

If its reserve increases, a bank is at liberty to increase its de- 
posits by extending its loans and discounts, attracting these, 
possibly, by lowering the discount rate. If the reserve is de- 
creasing, the bank must, for safety, contract its deposits by re- 
stricting its loans and discounts, or by taking measures (such as 
the sale of securities for money) that will replenish the reserve.^ 
In order that the ratio of reserve to deposits may be maintained 
near the point where the right balance is struck between profit- 
ableness on the one hand and safety on the other hand, it is nec- 
essary that the bank's assets should be a,s fluid as possible. This 
is best accomplished by confining most of the loans or discounts 
to notes or bills of exchange that are payable in thirty, sixty, or 
ninety days, or, at most, in four or six months, so that a constant 
flow of maturing obligations makes it possible for a bank to ex- 
pand or contract its loans and discounts, and hence its deposits, 
as seems most advisable. 

There has been in the larger cities of the United States, es- 
pecially in New York, a growing use of bank loans payable on 
demand. This enables the banks to keep their outstanding 
loans much closer to the maximum allowed by the state of their 
reserves than would otherwise be the case, but the practice has, 
as we shall see presently, other effects that are not so desirable. 

By the " money market " is usually meant the market for 
freely exchangeable rights to receive money on demand ; that is, 
in. reality, the bank credit market. The amount of bank credit 
available, the freedom with which banks will make loans on cer- 
tain kinds of securities, and the interest and discount rates 
charged for bank credit are among the things that make up what 
is called " the state of the money market." But it should be 
clear to the reader that the state of the money market depends, 

1 Some banks maintain a "bond reserve" of high grade securities that may be 
sold to enable the bank to meet an extraordinary demand for money or to enable 
it to extend its loans and discounts when necessary. Such investments are nor- 
mally made by commercial banks when the demand for loans does not absorb the 
fimds at the bank's disposal, that is, when money reserves are unprofitably large. 
U 



290 OUTLINES OF ECONOMICS 

primarily, on two things : first, the amount and nature of the per- 
sonal credit that can he exchanged for hank credit, and second, the 
amount of money in the hank reserves. 

Bank Notes. — There is one way, however, in which banks can 
meet some of the demand for money without drawing on their re- 
serves and thus reducing their power of extending credit. This 
is by the issue of bank notes, which are simply the promises of 
banks to pay money on demand, issued in convenient and famil- 
iar form for use as paper money. These notes are paid as money 
to customers of a bank who want the proceeds of their borrowings 
in cash, and to depositors and to holders of checks who prefer 
money to deposit credit. Bank notes pass readily from hand 
to hand as money, and at the present time constitute an impor- 
tant part of the circulating medium in most countries. 

Bank notes are like deposits in that both are demand liabilities 
of banks. Bank notes, however, circulate among persons who 
have no means of informing themselves as to the solvency of the 
banks issuing them. The holders of bank notes are accordingly 
usually given special protection by laws which regulate the con- 
ditions of their issue and redemption. 

State Banks of Issue. — Before the Civil War the actual circu- 
lating medium of the United States consisted in very large part of 
notes issued by banks operating under state laws. The notes 
issued by some of these banks were as " good as gold " because 
the banks redeemed them promptly in gold, — a fact which was 
due in some cases to wise and rigid state regulation of banking, 
and in other cases, fewer in number, to conservative use of the 
too extensive privileges granted by lax state laws. But the notes 
of other banks were depreciated and in many cases were abso- 
lutely worthless. 

Public ignorance of the real nature of banking gave rise to the 
supposition that wealth could be mysteriously manufactured by 
means of a bank charter and a printing press (the fiat money 
theory applied to bank notes) . This and the ever recurring de- 
mand for cheap money were responsible for the situation. Pro- 
hibited by the Constitution from issuing their own bills of credit, 
many of the states, especially in the South and West, responded 



CREDIT AND BANKING 29 1 

to the clamor for cheap money by making it possible for their 
citizens to organize " banks " and issue their own bills of credit, 
imposing few or no requirements as to the actual investment of 
capital, the accumulation of assets, or the restriction of note issue.^ 
In the panics of 1814, 1837, and 1857 but few banks maintained 
specie payments. Even so late as i860, although the hard 
lessons of experience had brought some improvements, especially 
in the older states, the bank note circulation was of decidedly 
varying quality. " Bank note reporters " and " counterfeit 
detectors " had to be issued periodically in order to give to busi- 
ness men the latest quotations and information relating to the 
depreciated currency they had to receive in the ordinary course 
of business. After 1861 the suspension of specie payments led 
to a general depreciation of bank notes as compared with gold, 
because most of them were thereafter redeemable only in green- 
backs. 

The National Banking System. — The successful state bank- 
ing system of New York was the model after which Congress, 
following the recommendations of Secretary Chase, patterned 
the national banking system which it established in 1863. The 
primary, although not the only, motive that led to this action 
was the desire to provide an artificial market for government 
bonds, which at the time were a drug on the market. National 
banks were required to use government bonds as the assets be- 
hind note issues, and furthermore, the national banks were, 
in 1866, given a monopoly of the note issue privilege by the im- 
position of a prohibitive tax of 10 per cent per annum upon the 
note issues of state banks. 

The details of the national banking law have been amended 
from time to time, but the general principles of the regulation 
of the note issue remained unchanged until Congress passed the 
Aldrich Act in igo8. As the law has stood since 1900, national 
banks may not be organized unless the stockholders contribute 
a minimum capital, varying from $25,000 for places of less than 

' Some states circumvented the constitutional prohibition mentioned by estab- 
lishing their own banks for the manufacture of paper money. The Bank of Ken- 
tucky was the most famous of these. 



292 OUTLINES OF ECONOMICS 

3000 population to $200,000 for places of more than 50,000 popu- 
lation. Three limitations are put on the ordinary issue of cir- 
culating notes : (i) They must not exceed in amount the capital 
stock of the bank. (2) United States government bonds have 
to be purchased by the bank in amount sufficient to equal, dollar 
for dollar, the quantity of the notes issued, and these bonds have 
to be deposited with the treasurer of the United States as secur- 
ity for the redemption of the notes. (3) Each bank must main- 
tain in the United States treasury a redemption fund in " lawful 
money " equal to 5 per cent of its note issue. As this last re- 
quirement indicates, bank notes are redeemable at the federal 
treasury. They may also be used in all payments to the govern- 
ment except customs duties, although they are not legal tender. 

The Reserve System. — While the note holder is thus pro- 
tected by a special kind of security set aside for the purpose, the 
depositor in a national bank is protected only by its general 
assets. These, however, are regulated to some extent by the 
federal government. There are restrictions, for example, in- 
tended to prevent the bank from tying up its funds in long-time 
investments, from lending too much to one person or firm, or to 
directors or officers of the banks. Five times a year national 
banks have to furnish full statements of their . condition to the 
comptroller of the currency at Washington. Each bank is also 
examined twice a year, without notice, by federal bank examiners. 

But the most important requirement relates to the money re- 
serves that must be held by national banks. Until the Federal 
Reserve Act was passed in 1913, banks in " central reserve 
cities " (New York, Chicago, and St. Louis) were required to 
maintain a " lawful money reserve " ^ equal to at least 25 per 
cent of their deposits. Banks in other " reserve cities " (in- 
cluding at present about fifty cities) were also required to main- 
tain 25 per cent reserves, but their deposits in the national banks 
of the central reserve cities might be counted for one half of this 
amount. In all other places the banks were required to hold 
a 15 per cent reserve, three fifths of which might consist of de- 
posit accounts in banks in central reserve cities or other reserve 

1 Including all kinds of United States money except minor coins and bank notes. 



CREDIT AND BANKING 



293 



cities. In all cases the funds kept by the banks with the United 
States treasurer for the redemption of their notes were counted 
as part of their legal reserves. 

The New York Money Market. — Under the operations of this 
system the cash reserves of the national banks were centered 
in New York. This appears clearly in Table I, which shows that 
on the date specified (which may be taken as fairly representa- 
tive of conditions in recent years) more than a third of the cash 
reserves of the 6544 national banks in the United States were in 

TABLE I 

Deposits and Reserves of National Banks: August 22, 1907^ 





No. OF 

Banks 


Deposits 2 


Reserve 


Classification of Reserve 


Location 





1 


Lawful 

money in 

bank 2 


Due from 
reserve 
agents 2 


rt .2 


New York . . . 


38 


825.7 


221.3 


26.8 


218.8 


— 


2.6 


Chicago .... 


14 


262.9 


66.6 


25-3 


66.1 


— 


0-5 


St. Louis .... 


8 


116.8 


27.6 


23.6 


26.8 


— 


0.7 


Other reserve cities 


306 


1423.4 


362.3 


25-5 


190.3 


165-7 


6.3 


Country banks . . 


6178 


2627.2 


443-5 


16.9 


199.6 


226.7 


17.2 


Total .... 


6544 


5256.1 


1 1 21. 4 


21.3 


701.6 


392-4 


27-3 



the vaults of thirty-eight New York banks.'* These figures do 
not, however, convey an adequate idea of the national impor- 
tance of the New York bank reserves. New York is the great 
wholesale market for foreign exchange, the chief center of gold 
movements to and from Europe, the principal importing and 
exporting center for commodities, — in short, the chief market 
place of the continent and the focus of financial operations. All 
state banks, private banks, and trust companies of importance 
find it to their advantage to maintain deposit accounts in New 

1 Compiled from Report of the Comptroller of the Currency, IQ07, pp. 222-224. 

2 Millions of dollars. ' Per cent. 

■• The bulk of the deposits of out of town banks was in from twelve to twenty 
banks which have made a specialty of this kind of business. 



294 OUTLINES OF ECONOMICS 

York, both for their own use, and in order that they may supply 
New York exchange to their customers. Even the deposit ac- 
counts of national banks in New York were in the aggregate 
considerably larger than the amount they were allowed to count 
as part of their reserves. 

All together the deposits of other banks have usually consti- 
tuted more than half of the aggregate deposits in New York 
national banks. Moreover, something very much like this re- 
serve system existed (and still exists) among other than na- 
tional banks, the banks in smaller places keeping deposits in 
national or other banks in larger cities, which in turn keep de- 
posits in New York. The trust companies, and some of the 
state banks/ keep in general very much smaller reserves in their 
own vaults than are required of national banks, — a fact which 
made the strain on the New York bank reserves all the greater. 

Like an inverted pyramid upon its apex, the great structure of 
bank credit in the United States has rested, in large measure, 
upon the money reserves of the New York banks. Every im- 
portant change in the demand for money or credit in any part 
of the country has had an effect on the New York money market ; 
similarly, every important disturbance in the New York money 
market has affected financial conditions throughout the country. 

The central reserve system effects a great economy in the use 
of money, and, what is more important, it mobilizes the cash 
resources of the country 'in such a way that variations in the local 
supply of bank credit in different regions resulting from differ- 
ences in the local supply of money available for bank reserves 
are minimized. It seems to be a natural and necessary feature 
of modern banking, for something like it is found in all the lead- 
ing commercial nations. But in the United States the central 
reserve system has worked badly. This has been attributable 
in part to other defects in our national banking laws and in part 
to some unfortunate features of the reserve system itself. Specifi- 
cally, the principal sources of difficulty have been the following : 

1 Savings banks keep reserves that average for the United States only four fifths 
of one per cent of their deposits. On account of the nature of their business, which 
is not banking in the commercial sense, they are a negligible factor in this connection. 



CREDIT AND BANKING 295 

(i) the dominance of speculative influences in the New York 
money market ; (2) the independent treasury system ; (3) the 
lack of elasticity in our bank note issues ; (4) the rigidity of our 
legal reserve requirements ; (5) the absence of any one central 
authority, responsible for the custody and maintenance of the 
central reserves. We now proceed to the discussion of these 
matters. 

Speculation and the New York Money Market. — As Table II 
shows, a large proportion of the loans of New York banks have 
not been based on " commercial paper " ; that is, on the notes 
and bills of exchange that arise in the ordinary course of business, 
but have been either time loans on collateral security or demand 
loans, nearly all of which are secured by collateral. Most of 
these collateral securities are the stocks and bonds of corpora- 

TABLE II 

Loans and Discounts of New York National Banks on Specified 

Dates ^ 
(In millions of dollars) 



Character of Loan 


1890 


1901 


1906 


1912 


On demand 


102 

43 

152 


279 
129 
203 


303 
149 
249 


344 
223 

391 


On time, with collateral security 

On time, without collateral security 



tions, and the loans, especially the demand or " call " loans, are 
used for the greater part in financing speculation in such securi- 
ties. This system has been partly responsible for the excessive 
and useless expansion of speculation over and above the amount 
that is necessary to secure the best results for the economic in- 
terests of the country. Here we are concerned, however, with 
its effects on the money market. 

The supply of call loans depends primarily on the amount of 
the surplus reserves of New York banks ; that is, the excess of 
the reserves over and above the legal minimum percentage of 
^ Compiled from Reports of the Comptroller of the Currency. 



/■ 

296 OUTLINES qt ECONOMICS 

the amount of their deposits. If the weekly statement of the 
clearing house banks shows a relatively large surplus reserve, 
this means that the banks can safely expand their loans, and the 
knowledge of this fact has a stimulating effect on speculation. 
If, however, the surplus reserve is low, the banks are bound to 
restrict their loans of all kinds and to " call " some of their de- 
mand loans. When the reserve is below the legal limit, demand 
loans have to be called in large quantities in order to enable 
the banks to meet pressing demands for credit on the part of 
their regular customers. The precipitate calling of demand 
loans by some banks simply increases the demand for credit at 
other banks, which in turn have to curtail their loans. Such a 
condition of the money market leads to a depression in the price 
of speculative securities, which is increased by the forced sales 
of securities in order to obtain the money funds that had pre- 
viously been lent on them ; the fall in the prices of securities 
leads brokers to demand more " margins " from the customers 
for whom they have bought securities, and it leads the banks to 
demand more securities as collateraf for their outstanding loans. 
Under such conditions the interest rate on call loans has some- 
times gone as high as 125 per cent, or even higher.^ 

If the ruling prices of speculative securities have been higher 
than industrial conditions would warrant, such a disturbance 
of the money market is apt to be long continued, and might 
easily develop into a general financial crisis. The call loan 
market is essentially speculative, and it is unfortunate that the 
condition of the supply of credit for the normal commercial needs 
of the country should have been periodically unsettled on ac- 
count of this fact. In no other great money center of the world 

1 That is, the rate on what may be called ^marginal call loans, effected at the 
stock exchange by bankers' agents, or by individuals or corporations. Many 
banks continue to make call loans to their regular customers at such times at rates 
not exceeding 6 per cent. Under normal conditions the rate on call loans is lower 
than the rate on time loans. For the period 1901-1906 the bank rate on call loans 
averaged 5.;^ per cent as against an average rate of about 4.5. per cent on time 
loans. Excessive variability is the chief characteristic of the call loan rate. Cf. 
W. A. Scott, "Rates on the New York Money Market," Journal of Political Econ- 
omy, vol. xvi, pp. 273-29S. 



CREDIT AND BANKING 297 

do call loans occupy the important place that they do in New- 
York. 

The Independent Treasury System. — The United States 
government has for many years been to a very large extent its 
own banker. It has kept its own money in its own strong boxes, 
quite after the fashion of a medieval monarch. The strong 
boxes in this case have been, however, the vaults of the treasury 
in Washington and of nine subtreasuries located in important 
cities. Apart from the fact that the government revenue and 
the government expenditures are naturally not distributed 
evenly throughout the year, the government has the further 
difficulty that a close balance of revenues and expenditures for 
any given year must be wholly accidental. Even if the federal 
budget were carefully and scientifically constructed, as it is not, 
the public revenues would be liable to uncertain fluctuations, — 
a result in part of the importance of customs receipts among 
them. The government, furthermore, receives a large part of 
its income in money, not in bank credit instruments. When a 
surplus accumulates in the government treasury, that much 
money is taken out of circulation. This reduces bank reserves, 
and contracts the amount of bank credit available. And it 
usually happens that the government revenues are largest when 
business is most prosperous, and when, consequently, maximum 
bank reserves are needed. 

The government is permitted, however, by the national bank 
act of 1863 to deposit money in selected national banks. Some 
secretaries of the treasury have made little use of this privilege, 
but in recent years such deposits have become more common. 

Until 1902 banks had always been required to deposit government bonds 
with the federal treasury as security for federal deposits, but in that year 
and again in 1906 Secretary Shaw offered to accept approved state and 
municipal bonds in lieu of a certain amount of government bonds, on condi- 
tion that the latter should be immediately used as security for increased 
note issues. Subsequently the banks have also been permitted to use 
"prime commercial paper," endorsed by the banks, as collateral. In 1897 
only 168 banks were government depositories. In 1914 there were 1584, 
which held on June 30 of that year about half of the $170,000,000 constitut- 
ing the government's cash surplus at that date. Part of this increase is 



298 OUTLINES OF ECONOMICS 

attributable to the effect of a law enacted in 1907 allowing customs receipts 
to be deposited in banks. Prior to this deposits could only be made from the 
proceeds of internal revenue duties and miscellaneous receipts. In recent 
years the banks have been required to pay 2 per cent interest on govern- 
ment deposits. 

The government has, on several occasions, come to the rescue of the banks 
by cash purchases of its own bonds. The dechne in the market price 
of government bonds in periods of financial stringency makes the purchases 
relatively advantageous to the government. The periodic shifting of govern- 
ment deposits to localities where money is most needed, the temporary de- 
posit of gold in New York banks equal in amount to their engagements 
of gold for transportation from Europe, and even the arbitrary withdrawal 
of government money from the banks when it was "not needed," in order 
that it might not be made the basis of speculative activities but kept until 
it "was needed," have been notable features of the recent relations of the 
treasury and the money market. 

In favor of this system it may be said that a surplus in the government 
treasury constitutes a real cash reserve, the wise use of which by the Secre- 
tary of the Treasury might avert a serious crisis. But there are dangers in 
intrusting so much financial power to one man. If used without discretion 
it is bound to do more harm than good. Moreover, these treasury operations 
have not always been free from the suspicion of favoritism to certain banks. 
Then, too, the knowledge that the government surplus will, in time of 
necessity, be put at their disposal tends to encourage unsound banking by 
relieving the banks of the proper responsibility for the maintenance of 
their own reserves. 

Finally, it should be noted, the use of the independent treasury system 
has prevented the government from securing for itself any large measure 
of the various economies and advantages that business firms find in keep- 
ing bank accounts. 

The Movement of Money. — The demand for loanable funds 
(rights to receive money on demand) varies locally, according 
to the business conditions that exist in different parts of the 
country. These differences make loans worth more in some lo- 
calities than in others, and result in some shifting of bank credit. 
New York banks, for example, sometimes invest in " out of 
town " commercial paper when this is more profitable than 
employing their funds at home. More frequently, interior 
banks place loans in New York, either through their correspond- 
ent banks there, or by the purchase of securities from note 
brokers. This shifting of credit, however, is unimportant as 



CREDIT AND BANKING 



299 



compared with the movement of money itself. Money is con- 
tinually flowing from New York to the interior and from the 
interior to New York, according as it can be more profitably em- 
ployed in bank reserves in one place or the other. Similar move- 
ments take place between the various cities of the country. This 
movement, it will be noted, is not one that is apt to disturb 
financial conditions. On the contrary, it tends to prevent ex- 
treme local fluctuations in money market conditions by leading 
to the expansion of credit where it is most needed, and similarly, 
to the contraction of credit where it is least needed. 

There is another kind of money movement, however, which is 
not so fortunate in its effects upon the money market. This is 
the movement of money out of bank reserves into general cir- 
culation and out of general circulation into bank reserves. The 
amount of money needed as an actual hand-to-hand medium of 
exchange varies for different seasons and for different localities. 
The demand for money to serve as the basis of credit in bank 
reserves and the demand for money as an actual medium of ex- 
change are different and competing demands. When more 
money is needed as a medium of exchange, reserves have to 
yield and credit has to be contracted. 

The most important movement of this sort is in response to the 
annual demand for money to be used in " moving the crops." 
Harvest expenses are very largely wages, and these have to be 
paid in cash. Many farmers, moreover, insist on receiving 
money payments when they sell their crops. The cotton crop 
of the South and the grain crop of the West annually necessitate 
the conversion of bank deposits in those regions into money, and 
the negotiation of loans on the security of the crops, the proceeds 
of which are also largely taken in cash. The banks in these sec- 
tions of the country in turn secure money from the banks in 
which they have deposits, and in large part this money is obtained 
directly and indirectly from the New York bank reserves. The 
movement of money from New York to the South and West 
usually commences in August of each year and continues through 
November, when the return movement sets in, continuing usu- 
ally till February. Despite the fact that the New York bankers 



300 OUTLINES OF ECONOMICS 

are forewarned of this movement, it always reduces their surplus 
reserves and leads to stringent and sometimes precarious condi- 
tions in the New York money market, — conditions which are 
frequently reflected in difficulties in the money market through- 
out the country. 

To the arbitrary flow of money to and from the treasury, and 
to its movement to and from bank reserves and hand-to-hand 
circulation, there must be added the movement of gold between 
this and other countries. This will be discussed in another 
place; it is sufficient to note at this point that this external 
money movement is at the same time a cause and an effect of 
changing money market conditions. 

Inelastic Currency. — That these money movements have af- 
fected the supply of bank credit as they have is partly at- 
tributable to the inelastic character of our bond-secured bank 
currency. Under the provisions of the national banking law that 
have been described, the variations in the amount of bank notes 
outstanding have borne a close relation to variations in the price 
of government bonds, — and these variations are affected by 
many other things than money market conditions, and in re- 
cent years have been very small. 

As will be seen in Table III, the creation of the two per cent 
bonds, payable in 1930, stimulated the issue of bank notes, be- 
cause the federal tax is only one fourth of one per cent semi- 
annually on bank notes secured by two per cent bonds as against 
one half of one per cent on notes secured by bonds paying a 
higher rate of interest. The relative stability of the amount 
issued in recent years has been noticeable, what increase there 
was being a natural result of the increasing number and size of 
banks. Nor has the amount of note issue responded in any 
marked degree to the regular seasonal demands for money to 
move the crops or to the less regular operations of the treasury 
department or of the foreign exchanges. 

Students of banking problems have for many years thought 
that the national banks should have been permitted to issue 
part, if not all, of their notes on the security of their general 
assets, thus placing them on the same basis as deposits. It is 



CREDIT AND BANKING 



301 



TABLE III ' 

Amounts of Bank Note Circulation Secured by Specified Classes 
OF Bonds: 1900-1915^ 



Secxjrity 


March 13, 1900 


Oct. 31, 1903 


Oct. 31, 191S 


Loan 1908, 3's 
Loan 1907, 4's 
Loan 1925, 4's 
Loan 1904, s's 
Loan 1891, 2's 
Consols 1930, 2's 
Panama Canal, 2 


's 








$56,164,820 

130,302,250 

14,697,850 

21,996,350 

20,490,150 


$1,797,580 

2,797,200 

1,410,100 

718,650 

376,003,300 


$20,377,720 
32,304,800 

600,678,600 
81,614,420 


Total . . 




$243,651,420 


$382,726,830 


$734,975,540 



clear that if this had been done any sudden increase in the de- 
mand for money as a circulating medium might have been met 
by exchanging bank credit in the form of bank notes for per- 
sonal credit, or by the shifting of bank credit from the form of 
deposits to the form of note issues. " Asset banking," as this 
is called, is used in Canada, and enables the banks there to fur- 
nish money for crop moving purposes without endangering their 
reserves. Most of the great national banks of continental 
Europe also issue notes on the security of their general assets. 
Under such a system, it is clear, the supply of bank notes 
can expand automatically with an increase in the supply of 
personal credit in the form of discountable notes and bills of 
exchange, in just the way that bank deposits expand. To 
achieve real elasticity, however, it is necessary to provide for 
the ready contraction of note issues when the special demand for 
money is over as well as to provide for their ready expansion in 
time of need. 

Inelastic Reserves. — Under our national banking law, banks 
have to stop lending when their reserves fall below the legal 
minimum. The central reserves in New York have accordingly 



1 From Reports of the Comptroller of the Currency, Finance Reports, 1907, p. 390 ; 
1915, P- 571- 



302 OUTLINES OF ECONOMICS 

been real reserves only in the sense that they have made it pos- 
sible for the banks to meet extraordinary demands for ready 
cash. So far as the extension of credit is concerned they have 
constituted, not a reserve, but a dead line.^ 

This has often had serious consequences. It is a well-tested 
principle of sound banking practice that about the worst thing 
that can happen when bank reserves are low is for the banks to 
stop lending. Business men, otherwise solvent, are not able 
to secure bank credit, and so cannot meet their own obligations 
or exchange their claims against their debtors for bank credit. 
Forced sales result ; the prices of securities and other forms of 
property fall ; the banks " call " their demand loans or ask for 
larger deposits of collateral securities ; more sales are forced, and 
the pressure on the banks for loans increases. In short, a general 
money market panic may come from suddenly curtailing loans 
at a time when bank reserves are relatively low. The wiser 
banking policy is to lend freely on good security, but at in- 
creased interest rates, thus automatically restricting loans to the 
more necessitous borrowers. 

The Bank of England, for example, permits its reserves to 
fluctuate between very wide limits, and often protects them 
against possible depletion by reason of withdrawals of gold to 
other countries by the simple process of raising its discount 
rate. Since the official Bank of England rate governs the 
general " open market rate " at which London banks discount 
commercial paper,^ the effect is not only that the amount of do- 
mestic borrowing is decreased, but also that the quantity of for- 
eign bills of exchange (normally bought in large quantities by 
London banks) sent to London for discount is decreased. Then, 



1 In practice the law has not been rigidly enforced, a warning from the Comptroller 
of the Currency being generally the only penalty exacted for a small temporary 
deficit in the reserves. Nevertheless, the New York bank reserves have not often 
fallen more than one or two points below the legal minimum. 

2 Sometimes, in order to make its increased rate "effective" in the London money 
market, the Bank borrows money or sells securities so as to decrease the available 
supply of loanable funds in the market, thus compelling the other London banks 
to increase their discount rate. Another device often used by the Bank in protecting 
its reserves is that of slightly increasing the price at which it buys gold. 



CREDIT AND BANKING 303 

as the foreign bills already held in London mature into rights to 
demand money from other money markets, these offset claims 
of other money markets against London which would otherwise 
have to be paid by shipping gold. 

Absence of Centralized Control. — It may have occurred to 
the reader that some elasticity might have been given to bank 
reserves in the United States if the banks holding the central 
reserves had made it their practice normally to hold reserves 
considerably larger than the minimum required by law, — re- 
serves equal to 40 or 50 per cent of their deposits, for example. 
This would have given a margin sufi&cient to enable them to 
meet withdrawals of gold for domestic use or for export without 
suddenly contracting the supply of loanable funds. All this 
is undoubtedly true, but it must not be supposed that such a 
policy could voluntarily have been followed by the New York 
banks. The difficulty was that the banks holding the central 
reserves were merely large commercial banks, interested pri- 
marily in securing maximum profits for their own stockholders, 
and with no one of them individually responsible for the main- 
tenance of adequate surplus reserves. For any one bank to 
have attempted to remedy the situation would have helped 
but little. It would only have put itself at a disadvantage as 
compared with its competitors. And then there were other 
factors in the situation that helped to keep the reserves pared 
down to a minimum. It is not economical for country banks to 
hold a much larger amount of actual money on hand than they 
need to comply with the law. Moreover, the New York banks, 
competing with one another for the deposits of other banks, 
pay 2 per cent interest on such deposits. In recent years about 
half of the aggregate amount of lawful money in the possession 
of the national banks of the country has been in the vaults of 
New York banks. WHat surplus reserves were created from 
time to time by importations of gold, by the transfer of money 
from the subtreasuries, by the reduction in the amount of money 
in hand-to-hand circulation, or by a contraction in the total 
volume of bank deposits, speedily found their way to the New 
York banks. And the New York banks speedily found ways of 



304 OUTLINES OF ECONOMICS 

utilizing the additional lending-power created by these surplus 
reserves. Stock exchange speculation, in particular, could 
generally be depended upon to absorb in the form of call loans a 
large part of the increased amount of available bank credit. 
In short, the operation of the system was such as continually 
to keep the ratio of reserves to deposits as close to the legal 
minimum as possible. Any " slack " that might appear was 
quickly taken up. 

These rigid and inelastic reserves were undoubtedly the worst 
features of our banking system. With more elastic reserves the 
evils of the independent treasury system and of inelastic cur- 
rency would not have been so great. Money could have flowed 
into reserves and out of them without often bringing conse- 
quences more serious than fluctuations in discount rates. 

Steps toward Reform. — The national banking system has 
in some particulars been highly successful. National, bank 
notes have always been thoroughly sound, and depositors, too, 
have been well protected, for failures of national banks have 
been relatively few. The high standards which the national 
banking system has set have had a marked influence upon 
the betterment of state banking laws and upon their enforce- 
ment. But the defects which have just been discussed made it 
both inadequate and, in its larger aspects, unsafe. Students 
of banking problems had for many years urged the need of re- 
form. Some advocated the establishment of a central hank, 
of the type that is found in almost every country of Europe. 
These banks hold the central banking reserves of their respec- 
tive countries, hold the government deposits, have (usually) a 
monopoly of bank note issue, and are subject to a special meas- 
ure of government control. But ever since the days of the 
Second Bank of the United States the establishment of a central 
bank in this country has probably been politically impossible. ^ 

iThe United States Bank (1791-1811) and the Second Bank of the United 
States (1816-1836) were large institutions, with numerous branches. But although 
they issued notes and held the treasury funds, they were not "central banks" in the 
modern sense. They did not have a monopoly of note issue, for state banks also 
issued notes, nor did they hold central banking reserves. In each case Congress re- 
fused to recharter the bank at the expiration of its original twenty-year charter. 



CREDIT AND BANKING 305 

More interest has been aroused, however, in the matter of elastic 
currency, and various plans for permitting national banks to 
issue notes secured only by their general assets have from time 
to time been embodied in bills introduced in Congress. But 
Congress, the business men of the country, and, it must be said, , 

the bankers themselves, were for the most part apathetic. V***^ 

General interest in the matter was finally aroused by the panic 
of 1907, in which the worst features of our banking system stood 
out in clear relief. Banks throughout the country found them- 
selves unable to meet the large and increasing withdrawals of 
money by their depositors and were unable in turn to get 
money from the banks in New York and the other central reserve 
cities in which they themselves had deposits. The payment of 
money to depositors had to be suspended or restricted, and 
many banks with perfectly sound assets found themselves, for 
the time being, technically insolvent. Money was at a premium. 
Clearing-house loan certificates — virtually joint obligations of 
the banks associated in the clearing house, issued to individual 
member banks upon the deposit of adequate security — were 
used (as in former panics) in the payment of clearing-house 
balances. In many cities the clearing-house loan certificates 
were issued in small denominations and got into general circula- 
tion by being paid to depositors in lieu of money. Cashier's 
checks and other credit instruments were also used as money. 
The total amount of improvised currency issued during the 
panic is estimated to have been over $500,000,000.^ The whole 
situation was such as to impress upon thoughtful men the im- 
perative need of banking reform. 

The first tangible result was the so-called Aldrich-Vreeland 
Act of 1908, which made temporary provision for such emer- 

In each case, also, this occurred when the country was temporarily under the domi- 
nance of a strong democratic sentiment opposed to pohtical or financial centraliza- 
tion in any form. Jealousy on the part of state banks was, however, the immediate 
cause of the demise of the first United States Bank, while the second succumbed to 
the yet more potent hostiUty of Andrew Jackson. 

1 A. P. Andrew, "Substitutes for Cash in the Panic of 1907," Quarterly Journal oj 
Economics, Vol. xxii, p. 515. For an excellent account of the general situation at 
the time see O. M. W. Sprague, History of Crises under the National Banking System, 
Chap. V. 

X 



3o6 OUTLINES OF ECONOMICS 

gencies as that of 1907 by permitting national banks to issue 
notes, under a heavy tax, upon other security than government 
bonds. The methods utilized were, in part, those which had 
been developed by the banks themselves in issuing clearing- 
house certificates. 

Under this measure banks might increase their note issues in one or both 
of two ways. First, on the security of approved state, county, or mimicipal 
bonds deposited with the Treasurer at Washington. Second, on the security 
of bonds of the kinds just mentioned, of corporation bonds, or of commer- 
cial paper, deposited with "National Currency Associations," which last 
were voluntary organizations, modeled upon clearing-house associations, 
although provision was made for their organization in country districts. 
These issues were limited in amount and were to be taxed at the very heavy 
rate of 5 per cent for the first month and i per cent for each additional 
month up to a maximum of 10 per cent. The act, it is evident, did not 
provide for a really elastic currency, varying with business needs, but 
only for an emergency currency. In 1913 the rate of taxation was reduced 
to 3 per cent for the first month, with a maximum of 6 per cent. 

For several years no notes were issued under this statute, but in 1914 the 
outbreak of the European war led to large shipments of gold to Europe and 
to a small-sized panic in the money market. The issue of emergency cur- 
rency possibly averted a more serious panic. Altogether, emergency notes 
to the amount of $386,000,000 were issued by 1363 different banks. All 
of these had been retired before the Act expired, by limitation, on June 30, 
1915- 

The Aldrich-Vreeland Act also created a National Monetary 
Commission, composed of senators and congressmen, to devise 
a plan for the general revision of the banking system. The plan 
recommended by this commission was one sponsored by Senator 
N. W. Aldrich of Rhode Island. It provided for a hierarchical 
organization of the banks of the country, with a central bank, 
the " National Reserve Association," at the top. Banks were 
to be grouped into local reserve associations, with functions not 
unlike those of the national currency associations of the Aldrich- 
Vreeland Act. The whole system was to be controlled by the 
banks rather than by the government. The widespread dis- 
cussion of the Aldrich plan undoubtedly did much to awaken 
interest in the problem and to. make the adoption of the federal 
reserve system possible. 



CREDIT AND BANKING 307 

The Federal Reserve System. — A revolutionary change in 
the banking system of the United States was brought about by 
the Federal Reserve Act of 1913. Under the provisions of this 
act the country has been divided into twelve districts and a cen- 
tral bank, named a Federal Reserve Bank, has been established 
in each district.^ The system is under the general supervision 
and control of the government. At its head is the Federal Re- 
serve Board, comprising five members appointed by the Presi- 
dent, together with the Secretary of the Treasury and the Comp- 
troller of the Currency. The stock of the various federal re- 
serve banks is owned by local banks in the respective districts, 
called " member banks." National banks were required to be- 
come member banks, while state banks and trust companies 
are permitted to become member banks, provided they comply 
with certain standards imposed upon national banks by the na- 
tional banking law and with other requirements set by the Fed- 
eral Reserve Board. Each member bank subscribes to the 
stock of the federal reserve bank in an amount equal to 6 per 
cent of its own capital and surplus. Half of this must be paid 
for, and the other half remains subject to call. Any earnings of 
the federal reserve banks over a 6 per cent dividend to their 
member banks go, first, to accumulate a surplus equal to 40 per 
cent of the paid up capital stock, and, beyond that, to the 
United States Treasury. Each federal reserve bank is governed 
by a board of nine directors, six being elected by the member 
banks, and three appointed by the Federal Reserve Board. 

Relations of Federal Reserve Banks and Member Banks. — The 
federal reserve banks are " bankers' banks " ; that is, they do 
not accept the deposits of individuals nor do they lend directly 
to individuals. Their most important relations are with their 
member banks, and these may be summarized under the heads 
of (i) reserves, (2) rediscoimts, and (3) note issues. 

I. The federal reserve banks hold the central reserves of the 

1 The twelve federal reserve banks are located at New York, Boston, Philadelphia, 
Richmond, Atlanta, Cleveland, Chicago, MinneapoUs, St. Louis, Kansas City, 
Dallas, and San Francisco. The Atlanta bank has a branch at New Orleans (with 
a special district assigned to it) and other branches may be estabUshed. 



3o8 OUTLINES OF ECONOMICS 

system. Three, years are allowed for the gradual transfer of 
reserves from the banks which have held them in the past. After 
that period the requirements are as follows: A member bank 
may count as reserve only (i) money in its own vaults and 
(2) deposit credits with the federal reserve bank. Member 
banks in central reserve cities must maintain reserves equal 
to 18 per cent of their demand liabilities, of which at least one 
third must be money in their own vaults and at least seven 
eighteenths deposits in the federal reserve bank. In other re- 
serve cities member banks must maintain 15 per cent reserves, of 
which at least one third must be in their own vaults, and at least 
six fifteenths must be a federal reserve bank deposit. Banks 
in other cities or rural districts must keep 1 2 per cent reserves ; 
at least one third in their own vaults and at least five twelfths 
in the federal reserve bank. The federal banks, in turn, have to 
keep minimum reserves of 35 per cent of their deposits. . 

These provisions for minimum reserves of definite size must be 
interpreted as being, in part at least, a concession to American 
habits and prejudices. But the Federal Reserve Board is 
authorized to suspend temporarily any of these reserve require- 
ments, imposing a graduated tax upon the amounts by which 
the reserves fall below the stated minimum limit. It is to be 
expected, moreover, that the federal reserve banks will normally 
hold reserves much larger than those required by law. This 
in itself will introduce a large measure of elasticity into the situa- 
tion. 

2. Rediscounting means the purchase by one bank of notes 
and bills of exchange held by another, the purchasing bank being 
protected by the selling bank's endorsement of the discounted 
paper. Rediscounting has not been a common feature of Ameri- 
can banking practice, and there has even been a distinct prejudice 
against it, although it is very common in Europe. The new law 
makes it an essential part of the federal reserve system. Federal 
reserve banks may rediscount (for their member banks) short- 
time notes and bills of exchange " issued or drawn for agricul- 
tural, industrial, or commercial purposes," and conforming 
to certain specifications which have been carefully formulated 



CREDIT AND BANKING 309 

by the Federal Reserve Board. The privilege X)f rediscount is 
not extended to notes and bills of exchange issued " for the 
purpose of carrying or trading in stocks, bonds, or other invest- 
ment securities, except bonds and notes of the United States." 
The purpose of this restriction is not only to prevent the resources 
of the federal reserve banks from being used to finance specula- 
tion, but also to limit their rediscounts to so-called " self-liqui- 
dating paper," that is, to notes and bills of exchange held against 
loans which the borrowers will, in the ordinary course of business, 
be able to repay from the proceeds of the sales of the goods pro- 
duced or purchased with the aid of the borrowed funds. ' 

The most important general advantage of this new redis- 
counting system is the help it will give in the development of a 
thoroughly elastic supply of deposit credit, expanding and con- 
tracting with the number and magnitude of business transac- 
tions. When, for example, the reserves of certain member 
banks are too low to permit them to advance deposit credits 
to their customers in the desired quantities upon even the sound- 
est instruments of personal credit, they may replenish their 
reserves by sending part of their holdings of bills and notes to the 
federal reserve banks for rediscount. In order to equalize the 
supply of bank credit in different parts of the country the Fed- 
eral Reserve Board may permit and even require certain federal 
reserve banks to rediscount commercial paper for other federal 
reserve banks. The Federal Reserve Board also has general 
supervising power over the whole rediscounting system, includ- 
ing power to revise the rediscount rates of the different federal 
reserve banks. 

3. Under the new system, national banks may still continue 
to issue notes, as in the past, if they wish. The existing national 
bank notes, constituting about one fifth of the aggregate amount 
of money in the country, could not be suddenly withdrawn from 
circulation without serious consequences. But the Federal 
Reserve Act provides that the national banks may gradually 
get rid of their note-issue liabilities by selling the government 
bonds they hold as security for their notes to the federal reserve 
banks at par. The federal reserve banks, if they wish, may 



3IO OUTLINES OF ECONOMICS 

utilize these bonds as security for the issue of federal reserve 
bank notes, which in all essentials are like national bank notes. 
The extent to which national banks will give up their note issues 
will depend very largely upon the price of government bonds. 

More important, however, are federal reserve notes, issued by 
the federal reserve banks (i) in exchange for gold, thus becoming 
virtually gold certificates, and (2) upon the security of redis- 
counted paper held by them. A 100 per cent reserve is held 
against notes issued in exchange for gold ; a 40 per cent reserve 
has to be held against notes issued on the security of rediscounted 
paper. This last reserve requirement may, in emergency, be 
waived by permission of the Federal Reserve Board, a graduated 
tax being imposed upon deficiencies in the reserve. This makes 
it possible, it will be seen, for member banks to secure currency for 
their own borrowers and depositors by sending paper to the 
federal reserve banks to be rediscounted, taking the proceeds 
of such rediscounts in federal reserve notes. This means that 
when the country needs more money for hand-to-hand circula- 
tion it can get it by exchanging personal credit instruments for 
federal reserve notes. Bank credit in the form of bank notes 
can now be expanded quite as readily as bank credit in the form 
of deposits. But it is not yet certain that an adequate mecha- 
nism has been provided for the speedy contraction of the note issue 
when the special needs that called for its expansion have passed. 
Federal reserve notes are redeemable at the issuing banks and 
(out of a redemption fund maintained by the banks) at the treas- 
ury in Washington, and no federal reserve bank which has re- 
ceived the notes of another federal reserve bank is permitted 
to pay them out, but must return them promptly to the issuing 
bank " for credit or redemption." Much depends then, so far 
as contraction is concerned, upon the rapidity with which federal 
reserve notes find their way back to some federal reserve bank.. 

Other Functions of the Federal Reserve Banks. — In addition 
to being " bankers' banks," the federal reserve banks, it is 
expected, will be bankers for the federal government. They 
may, under the law, be used as depositories for all the general 
funds of the government and may serve as " fiscal agents " of 



CREDIT AND BANKING 311 

the government in various treasury operations. This will make 
it possible for the government to use modern and economical 
methods in caring for its receipts and making its payments, and 
should also prove of advantage in its borrowing. 

The federal reserve banks are also empowered to buy, sell, and 
borrow gold coin and bullion, the securities of the federal govern- 
ment, and the warrants and other short-time obligations of states 
and municipalities. They may also buy and sell bills of exchange 
arising out of either foreign or domestic trade. This last power 
enables them, in case of need, to come to the relief of banks not 
members of the system. Buying bills of exchange from other 
banks differs from " rediscounting " only in that in the latter 
process the bills to be rediscounted are normally and usually 
exchanged for deposit credits or bank notes. Under the law, 
federal reserve notes cannot be issued upon the security of " pur- 
chased " paper, but only upon paper " rediscounted " for member 
banks, nor can federal reserve banks give deposit credit to banks 
not in the system. This means that since " purchases " will 
usually involve a direct drain upon the reserves of the federal 
banks, their power of " purchase " is much more restricted than 
their power of " rediscount." 

But there is a yet more important aspect of these authorized 
" open-market operations " in commercial paper. Only through 
the use of this power can the federal reserve banks hope to make 
their discount rates " effective " in the money market. Only 
in this way can they expect to " put on the brakes " when they 
think that bank credit is being expanded with dangerous rapidity 
or encourage free lending on the part of the banks when condi- 
tions are such as to make that policy seem desirable. Only in 
this way, moreover, can they protect their gold reserves by the 
use of devices similar to those which the Bank of England and 
other European banks have found effective. The existence of 
an " open market " for commercial paper means merely that 
commercial paper, instead of being held till maturity by the 
bank first discounting it, may be bought and sold freely, and 
may move from one city to another and even from one country 
to another, according to differences in prevailing discount rates. 



312 OUTLINES OF ECONOMICS 

In the United States open market operations of this kind are not 
yet of sufficient magnitude to give the federal reserve banks any 
large opportunity for exerting their influence. They are con- 
sequently endeavoring to stimulate the growth of open-market 
operations. 

The federal reserve system has been very carefully devised 
for the purpose of getting rid of the principal evils inherent in 
the national banking system as it was. If given a thorough and 
fair test, it should accomplish that purpose. There is some 
danger that the new system may make possible a too easy and 
too rapid expansion of bank credit in periods of business pros- 
perity, ending perhaps in reaction and crisis. But this danger 
is inseparable from any really elastic system of bank credit. 
With a wise exercise of the powers which the Federal Reserve 
Board has over discount rates and reserves, the alternations of 
periods of business prosperity and periods of business depression 
should be less frequent and less violent than in the past, f' 

The most formidable obstacle to the success of the federal reserve system 
now apparent is the possible lack of cordial cooperation on the part of the 
banks — especially the smaller banks — of the country. Very few state banks 
and trust companies have become member banks, while a few member banks 
have given up their national bank charters and have withdrawn from the 
system. Despite the fact that the Federal Reserve Act modified the na- 
tional banking law by permitting national banks to engage in various kinds 
of banking operations which had previously been prohibited, some of the 
bankers feel that membership in the system decreases their banking profits. 
Member banks no longer get interest on their reserve deposits (although 
this is compensated for, at least in part, by the reduction in the size of the 
required reserves) and, if they utilize the federal reserve banks as clearing 
and collection agencies for checks drawn upon other banks in the system, 
they lose some of the profits from certain charges that had previously been 
made for collections and exchange. The advantages of the system to in- 
dividual banks will appear most clearly at time of crisis. But lessons of 
periods like that of igoy are soon forgotten. The greatest advantages of 
the system, however, are its effects upon the commercial interests of the 
country as a whole. A particular banker may feel that he can share in 
many of the general advantages of the system without membership in it. 
It is to be hoped that this absence of a sense of individual responsibility for 
the general banking situation may not develop so far as to prevent the fed- 
eral reserve system from attaining its maximum usefulness. 



CREDIT AND BANKING 



3T^3 



TABLE IV 

Combined Resources and Liabilities of the Federal Reserve 
Banks: July 21, 19161 

(In thousands of dollars) 



Resources 


Liabilities 


Total reserve . . . . . 


377,343 


Capital paid in . . . 


55,183 


Five per cent redemption 




Government deposits . 


54,277 


fund against federal re- 




Member bank deposits . 


492,000 


serve bank notes . . . 


A 50 


Federal reserve notes ^ . 


10,120 


Bills discounted for mem- 




Federal reserve bank 




bers 


28,937 


notes 


1,692 


Bills bought in open mar- 




Other liabilities . . . 


. . .251 


ket 


85,382 






United States bonds . . 


49,746 






One-year treasury notes . 


7,190 






Municipal warrants . . 


27,723 






Federal reserve notes, net 


20,014 






Other resources .... 


16,738 






Total 


613,523 


Total 


613,523 



The Present Position of State and Private Banks. — The 
figures in Table V give only a partial idea of the present posi- 
tion of banking in the United States, for vi^hile they are com- 
plete as to national banks, there were, in 191 5, over 3000 
other banks w^hich failed to make reports to the Comptroller 
of the Currency. 

"State banks," in the narrow sense, include only corporations chartered 
by the individual states to conduct a general commercial banking business. 
In a broader sense savings banks and trust companies incorporated under 
state law may be said to be state banks. 

1 Compiled from statements in Federal Reserve Bulletin, Vol. ii, pp. 426, 427. 

2 Federal reserve notes to the amount of $175,210,000 were outstanding at this 
date but a large porportion of these were covered by gold set aside for the purpose 
(and not included in the statement of resources) and others remained in the hands 
of issuing banks. The amount in circulation was $154,038,000. 



314 



OUTLINES OF ECONOMICS 



TABLE V 

Number of Banks and Amount of Deposits in Specified Kinds of 
Banks: 1915^ 



Number 
OF Banks 



Deposits 2 



State banks 

Savings banks .... 
Private banks .... 
Loan and trust companies 
National banks . . . . 

Total 



14,598 
2,159 
1,036 

1,664 
7,605 



?3, 277, 772,000 
4,997,706,000 
134,410,000 
4,204,596,000 
6,569,859,000 



27,062 



519,184,343,000 



Savings banks do not usually do a commercial banking business ; that is, 
they are not engaged in the sale of bank credit in a form that can be used in 
making payments. Their deposit accounts are not usually transferable by 
means of checks. They receive deposits of small savings and invest them 
in long time securities, such as real estate mortgages and bonds of various 
sorts. They perform an important social service by stimulating saving and 
by increasing the financial power of small investors through concentrating 
and combining their resources. Savings banks are organized either as cor- 
porations or as mutual societies managed by a board of trustees acting for 
the depositors. The latter type is especially common in the eastern states. 

Trust companies were at first organized to take charge of trust funds and 
to act as executors and administrators of estates. They have, however, 
developed the functions of both savings banks and commercial banks, and 
have even entered such specialized banking fields as foreign exchange and 
the underwriting of corporation securities. They have thus the character 
of free lances in the banking field. Their banking functions have developed 
so rapidly that in many states they have been put under no such rigid control 
as is exercised over state and savings banks. 

Private banks are of two very distinct tj^es. Some are small unincor- 
porated banks in coimtry towns. Others are great concerns in the financial 
centers which deal in investment securities, buy and sell foreign exchange, 
finance great corporate undertakings, and, in some cases, act as brokers in 
the stock market. 

It is impossible, in fact, to draw a definite line between "banking" and 

1 Compiled from Report of Comptroller of the Currency, Finance Report, 1915, 

pp. 533, SOS- 

2 Exclusive of inter-bank deposits and postal-savings deposits. 



CREDIT AND BANKING 315 

other financial undertakings. Building and loan associations, private money 
lenders, note brokers, dealers in investment securities, life insurance com- 
panies, etc., frequently perform fimctions which are very much Hke some 
kinds of "banking." But banking as the institution which converts per- 
sonal credit into bank credit in the form of deposit accounts and bank notes 
is a clearly defined thing, and has a distinct economic significance of its own. 

QUESTIONS 

1. Explain the various items in the published "statement" of a na- 
tional bank. 

2. Because a national bank can buy interest-bearing government bonds 
and use them as security for its own issues of paper money, advocates of 
government paper money issues have alleged that it gets "double interest 
on its money." Is this true? 

3. How should one compare the profitableness of issuing notes with the 
profitableness of extending deposit credit? 

4. What restrictions does your state impose on state banking corpora- 
tions? 

5. Report on the note-issue systems of the Bank of England, the Bank 
of France, the Imperial Bank of Germany, and the Canadian banks. 

6. Report upon the relative advantages of the promissory note and the 
bill of exchange as instruments of commercial credit. 

7. Compare the provisions of the Aldrich plan with those of the federal 
reserve system. 

8. Does the supply of bank credit involve the sacrifice of "waiting" 
on the part of anyone? Who are the real or ultimate lenders? 

9. What are bank acceptances ? trade acceptances? commodity paper ? 
ID. Are bank notes more closely analogous to government paper money 

or to bank deposits? 

II. What points of superiority have bank notes over government paper 
money? 

REFERENCES 

(See also references for Chapter XIV.) 

Comptroller of the Currency. Annual Reports. 

CoNANT, C. A. History of Modern Banks of Issue. 

Conway, Thomas, and Patterson, E. M. The Operation of the New Bank 

Act. 
Dunbar, C. F. Chapters on the Theory and History of Banking. 
Federal Reserve Board. A nnual Reports ; Federal Reserve Bulletin (monthly) . 
HOLDSWORTH, J. T. Money and Banking. 
Knox, J. J. History of Banking in the United States. 
Laughlin, J. L. (editor). Banking Reform. 



3l6 OUTLINES OF ECONOMICS 

National Monetary Commission. Publications. (A series of over forty mono- 
graphs by different authors, giving as a whole the best available history 
of banking in the United States and the best accounts in English of the 
banking institutions of other countries.) 

Pratt, S. S. The Work of Wall Street. 

Sumner, W. G. History of Banking in the United States. 

Willis, H. P. The Federal Reserve; American Banking. 

Withers, Hartley. The Meaning of Money. 



CHAPTER XVI 
OTHER PROBLEMS IN MONEY AND BANKING 

The Value of Money. — We have not as yet answered one 
very important question, and that is, " What determines the 
value of money? " Now by the " value of money " we mean 
the purchasing power of money as reported or expressed by 
the money prices of other things. There is no such thing in 
fact as " the general purchasing power of money," although we 
have found it convenient to use that and similar expressions. 
Money has, in reality, a large number of different values, ex- 
pressed by the different quantities of different things that it 
will purchase. If the price of wheat is one dollar per bushel, 
then one value — the wheat value — of money is a bushel per 
dollar. Similarly, the purchasing power of money in sirloin 
steaks may be four pounds per dollar. But how are we to 
blend sirloin steaks, wheat, and other things into one concept? 
The notion of the general value of money is simply a useful 
abstraction, based on a broad view of all its different specific 
values. 

When we fix our attention upon changes in the various pur- 
chasing powers of money, however, we are able to make a dis- 
tinction between changes that are widespread and general, 
and changes that affect only one or two commodities. For 
example, a new invention may decrease the price of a particular 
commodity, without affecting the prices of other things except 
(if the demand for the commodity is elastic) by shifting demand 
from other things to the commodity in question, — • an effect 
which would usually be slight so far as the price of any one of 
these other things is concerned, for the demand would very 
likely be shifted from many different lines of consumption. Or, 
if the demand for the commodity in question is relatively in- 

317 



3l8 OUTLINES OF ECONOMICS 

elastic, a diminution in its price may increase the demand for 
other things. But there are, on the other hand, price fluctua- 
tions which are widespread and which show a general trend in 
one direction or the other, and these we may call, with substan- 
tial accuracy, changes in the value of money. What are the 
underlying causes of these general changes in the values of 
money ? 

The Nature of the Problem. — Our first impulse, perhaps, 
is to suggest that there is no new problem here, that the value 
of money is to be determined in the way that other values are 
determined, and to seek to frame an explanation in terms of 
marginal utility and the genera.1 laws of supply and demand. 
But the task is not so simple as that. The analysis of marginal 
utility, it is true, formed the basis of our explanation of the 
shifting of demand from one commodity to another, but it does 
not help us to explain the demand for money, Marginal 
utility depends upon the capacity of things to satisfy human 
wants, and money does not directly satisfy a single human 
want, except the abnormal wants of the miser. We want 
money only as we want the things that money will buy for us. 

And when we turn to " supply and demand " we find at first 
little help. For, it will be remembered, when we were discuss- 
ing the relations between the prices of things and their supply 
and demand, we arbitrarily limited ourselves to the consider- 
ation of one commodity at a time. That is, we assumed that 
the money price of the one commodity we were considering was 
alone variable, and that the prices of all other things remained, 
for the time being, constant. The consumer whom we pictured 
as willing to buy a certain amount of a commodity at a certain 
price or a larger amount at a lower price, was, by our premises, 
merely comparing variable dollars' worths of the commodity in 
question with fixed dollars' worths of other things. All the 
values of money, save one, were held constant, so that the 
imaginary consumer simply had to equate the utility of larger 
and smaller marginal dollars' worths of the one commodity 
to their cost measured in a dollar that represented perfectly 
definite amounts of all other things. Now the problem of the 



OTHER PROBLEMS IN MONEY AND BANKING 319 

value of money (understood as the problem of general changes 
in the different values of money) cannot be approached in 
that way. For the problem of the value of money is merely 
the obverse of the problem of the money values of all other 
things. If we were studying the wheat value of money we 
could assume the sirloin-steak value of money to be held 
constant. But our present problem is that of the wheat value 
of money and the sirloin-steak value of money and all other 
values of money. We can't resort to the strategy of breaking 
the sticks in our bundle one by one. 

The Quantity of Money and the Values of Money. — All 
this does not mean that there is no such thing as a '' demand 
for money." Using the word money in its broadest sense, 
including all " rights to receive money " that are used in mak- 
ing paymients, it is clear that every sale of a commodity may 
be viewed as a purchase of money, and every purchase of a 
commodity as a sale of money. Going a step farther, and 
remembering that one wants money only because of the things 
money will buy, we may say that every sale of one commodity 
is a purchase of the power of acquiring other things. A seller 
cares nothing about the quantity of money — the number of 
dollars — he gets in exchange for his goods, except in so far as 
these dollars have certain exchange relations with other things, 
including the things he buys as a consumer and the things he 
pays for under the head of " expenses of production." Simi- 
larly, a buyer cares not how much money he parts with in ex- 
change for a definite quantity of goods, except in so far as the 
money has alternative uses of greater or less importance. The 
quantity of money — the number of dollars in the aggregate 
supply of the instruments in which payments are made — has 
no significance apart from the values of the dollars. 

These two things — quantity and value — are in the case 
of money bound together in a peculiar way. They are, in a 
very real sense, not only interdependent but interchangeable. 
A small amount of money of high purchasing power per unit 
will meet the needs of both buyer and seller just as well as a 
larger amount of money of lower purchasing power per unit. 



320 OUTLINES OF ECONOMICS 

What are the conditions under which a general change in the 
values of dollars is possible? Let us simplify the problem by- 
assuming that the change is absolutely general and uniform; 
that if, for example, the price of a bushel of wheat is seventy-five 
cents and the price of a bushel of corn is fifty cents, an increase 
in the price of wheat to a dollar and a half is accompanied by 
an increase in the price of corn to a dollar, and by a similar 
doubling of the money prices of all other commodities and 
services. Things retain, we shall assume, precisely the same 
exchange relations as before, except with reference to money. 
If prices have thus increased, all the values of money have di- 
minished by one half. As an intermediary, then, as a means of 
obtaining other things, money has only half its former potency. 

Sellers are demanding and receiving twice as many dollars 
as before for given quantities of goods ; buyers are offering and 
paying twice as many dollars as before per unit of goods pur- 
chased. Remembering now that we are using the word money 
in its broadest sense, including exchangeable credit instru- 
ments, it is evident that twice as much money as before passes 
from buyer to seller in exchange for every unit of everything 
else that passes from seller to buyer. But this means that 
one of two possible conditions must exist. Either (i) fewer 
exchanges are being made, or (2) exactly twice as much money 
as before is being exchanged for goods and services. So we 
reach the very important conclusion that there must be a 
definite relation between general changes in the values of 
money and changes in its quantity. We need not as yet con- 
cern ourselves with the question of which of these two related 
things is cause and which is effect. But that these two things 
are inseparably bound up, the one with the other, should now 
be clear. 

We may now state this principle in a somewhat broader 
form : // the number of units of goods and services of every sort 
annually exchanged for money remains constant, any increase or 
decrease in the amount of money used in making payments must 
he accompanied by an exactly proportionate general increase or 
decrease in prices. It is not necessary for the truth of this 



OTHER PROBLEMS IN MONEY AND BANKING 321 

theorem that all prices should change in the same proportion. 
The general change in prices may, for example, be upward, 
but some prices may rise by a smaller proportion or may even 
fall, provided these are offset by sufSciently large increases 
in the prices of other things. An " exactly proportionate " 
general change in prices merely means such changes in specific 
prices as will make possible an unchanged volume of transac- 
tions with the increased or decreased number of dollars used in 
making payments. A general increase or decrease in price is 
of course identical with a general decrease or increase in the 
various specific values of money. 

The Equation of Exchange. — Some aspects of the general 
relation between prices and the quantity of money can be con- 
veniently represented by using algebraic symbols. Let M 
represent the total amount of money in circulation, and let V 
represent its rate of turnover, or velocity of circulation, that 
is, the average number of times the various dollars in circulation 
are exchanged for goods or services during the year. Then 
MV will represent total money payments, measured in money 
units. Let T represent the total volume of trade, or, more 
accurately expressed, the total number of units of commodities 
and services exchanged for money during the year. Finally, 
let P represent the average price per unit paid for these com- 
modities and services. The equation of exchange may now be 
stated in its simplest form : 

MV = PT. 

This equation, it is obvious, amounts to the statement that 
the quantity of money in circulation, multiplied by its average 
rate of turnover, is equal to the average price per unit paid for 
commodities and services, multiplied by the number of units 
sold. This, in turn, is equivalent to the yet simpler statement 
that the total amount of money paid for things during the year 
equals the sum of the prices of all the units purchased. Stated 
in this way, the equation of exchange is readily seen to be 
necessarily true. In fact, it is a truism, — an identity, almost, 
rather than an equation. But it is none the less significant, 

Y 



32 2 OUTLINES OF ECONOMICS 

for the truism which it states is one which has very often been 
forgotten. 

Up to this point we have simphfied our problem by counting 
as " money " everything, including credit instruments, expressed 
in terms of dollars and accepted in payment for other things. 
But there are some important problems connected with the 
relation of changes in the quantity of the generally accepted 
media of exchange (money in the " narrower sense ") to changes 
in prices. So we shall now let M represent the quantity of the 
generally acceptable media of exchange, including metallic 
money, government paper money, and bank notes. The sym- 
bol M' will be used to represent the quantity of the trans- 
ferable " rights to demand money " that are used in making 
payments. These consist, almost entirely, of bank deposits 
subject to check. Then the equation of exchange becomes : 

MV + M'V' = PT. 

This is a statement in algebraic symbols of the fact that the 
amount of money in circulation, multiplied by its rate of turn- 
over, together with the amount of bank deposits subject to 
check, multiplied by their average rate of turnover, must be 
equal to average unit prices, multiplied by the number of units 
of things exchanged for money or for deposit credit. This equa- 
tion is identical with the other one, except that a distinction is 
now made between money and bank deposits. The principal 
advantage of the use of the equation of exchange, in fact, is 
that it enables us to discuss the relations between general 
changes in prices and changes in the amount of metallic and 
paper money without becoming involved in difficulties of analy- 
sis and of exposition that would otherwise be very formi- 
dable. The problem becomes simply that of the relations be- 
tween M and P in the equation of exchange. 

If M and M' increase in equal proportion, while V, V, and 
T remain fixed, P must also increase proportionally. That is, 
all other things being equal, an increase in the amount of money 
in circulation and in bank deposits must be accompanied by a 
proportionate increase in prices. To what extent, in fact, are 



OTHER PROBLEMS IN MONEY AND BANKING 323 

these " other things " likely to remain equal? In the first place 
a sudden increase in the amount of money in circulation is 
very sure to increase T, the total volume of trade, by leading 
to increased purchases. But in the long run the increase or 
decrease of the total volume of trade must depend upon the 
natural resources of the country, the productive energies of the 
people, and the degree to which division of labor has been 
achieved. It can have no permanent dependence upon the 
amount of money in circulation. In the second place, a sud- 
den increase in the supply of money is likely to bring about a 
temporary decrease in V, its velocity of circulation, because a 
larger amount of money may, for the time being, be kept idle. 
But, with a given volume of transactions at given prices, V 
must in the long run depend very largely upon the habits of 
the people with respect to the amount of " pocket money " 
usually kept on hand. Changes in habits of this kind are 
slow, and may safely be neglected in studying the movement 
of prices through even a considerable number of years. 

When, in the third place, we come to consider the effect of an 
increase in M upon the magnitude of M', the amount of bank 
deposits subject to check, we find that these two things are 
necessarily connected. For an increase in M, the amount of 
money- in circulation, is very sure to be accompanied by an 
increase in bank reserves. Additions to the country's stock of 
money will distribute themselves, ultimately, between bank 
reserves and hand-to-hand circulation, and the proportions of 
the country's monetary stock allotted to these two uses usually 
fluctuate only between more or less definite, even if gradually 
changing, limits. But an increase in bank reserves normally 
brings with it an increase on M', the amount of bank deposits 
subject to check. Even in the absence of minimum reserve 
laws, the ratio of aggregate bank reserves to aggregate bank 
deposits is found, for the time being, to fluctuate around an 
approximately constant proportion. An increase in M, there- 
fore, is very sure to result in an increase in M'. 

It follows, then, that despite a certain amount of variability 
in the other factors in the equation of exchange, an increase in 



324 OUTLINES OF ECONOMICS 

Mj carrying with it a roughly proportionate increase in M', 
must normally have as its most important concomitant a 
similar general increase in prices. This, it will be noted, is in 
harmony with the conclusion we had already reached without 
the aid of the equation of exchange. But that conclusion was 
stated in terms of the " amount of money (and credit instru- 
ments) exchanged for goods and services," the volume of trade 
being constant. We now see that a similar conclusion holds 
true when stated in terms of the quantity of money in circula- 
tion, the only qualifying factors being probable changes of 
greater or less importance in (i) the rate of turnover of money, 
(2) the ratio of the amount of money in bank reserves to the 
total amount of money in circulation, (3) the ratio of bank 
reserves to bank deposits, and (4) the rate of turnover of bank 
deposits. Allowing for the influence of these qualifying factors, 
an increase or decrease in the quantity of money, the volume of 
trade being constant, must be accompanied by a proportionate 
general increase or decrease in prices. This principle, known 
as " the quantity theory of prices," has long been one of the 
most important theorems of economics.^ 

General changes in prices must, of course, accompany changes in any of 
the factors in the equations of exchange, unless these happen to counteract 
one another. If the volume of trade increases more rapidly than the supply 
of money, and other things remain equal, prices must decrease. This is 
the apparent explanation of the general fall in prices between 1873 and 1897. 
The growing use of checks in making payments is substantially like an 
increase in the supply of money. It increases the ratio of money in bank 
reserves to money in hand-to-hand circulation, and thereby increases the 
ratio of M' to M. Unless offset by changes in other factors, this must be 

1 Professor Irving Fisher, by making skillful use of such statistics as are available, 
has estimated the magnitude of the various items in the equation of exchange for 
each year since i8g6. For one factor, the total volume of trade, Professor Fisher 
had to be content with relative figures, showing merely the estimated percentage 
changes in the volume of trade from year to year. By using merely his figures for 
M, V, M', V', and T, Professor Fisher was able to get values showing the relative 
year-by-year changes in P which agreed very closely with figures derived from 
the statistics of actual price movements. Similar estimates, based on somewhat 
less complete statistics, had previously been made by Professor E. W. Kemmerer. 
See Fisher, The Purchasing Power of Money; and Kemmerer, Money and Credit 
Instruments in their Relations to General Prices. 



OTHER PROBLEMS IN MONEY AND BANKING 325 

accompanied by rising prices. An improvement in the organization of the 
banking system, making possible a smaller normal ratio of aggregate bank 
reserves to aggregate bank deposits must also tend to increase prices. 
Along with a phenomenal increase in the quantity of money in the past 
twenty years there has been, in fact, a large increase in both the ratio of 
deposits to money and in the rate of turnover of deposits. 

The Mechanism of General Changes in Prices. — Thus far 
we have considered only the mathematically necessary relations 
between changes in the quantity of money and general changes 
in prices. The quantity theory of prices, even when stated in 
the form of the equation of exchange, tells us nothing about the 
process of general price changes ; nothing, that is, about the 
mechanism by which a change in the quantity of money oper- 
ates to bring about general changes in prices. No one has ever 
given a complete description or analysis of this process, and 
doubtless no one description would fit all instances of general 
price changes brought about by changes in the quantity of 
money. But some aspects of the matter are tolerably clear. 

Take an artificially simple case. Imagine an isolated com- 
munity with no foreign trade and with no banks. Suppose 
that a group of men find a long-forgotten hoard of gold, large 
even as compared with the existing stock of gold in circulation. 
Without increasing their own activities as producers the finders 
are now able to purchase larger quantities of goods. These 
additional purchases, it is important to note, are the direct 
result of the increase in the supply of money, and could not have 
been made without it. The merchants into whose hands the 
money comes in turn expend it to replenish their stocks and for 
other purposes. And so the money passes from hand to hand, 
increasing the number of exchanges — the volume of trade — 
just about proportionately to the increase in money. 

But this increase in the volume of trade cannot be the end 
of the process. More goods than before are passing into the 
possession of their ultimate consumers. The country's stock 
of exchangeable goods is being depleted more rapidly than it 
can be replenished out of the country's normal agricultural and 
industrial output. In short, the purchasing power of the com- 



326 OUTLINES OF ECONOMICS 

munity, at the old level of prices, is now more than sufficient to 
buy the current output. Under the pressure of competing 
purchasers, desiring to exchange money for goods, prices will 
rise. And if the industrial output cannot be permanently in- 
creased the rise in prices will be proportionate to the increase 
in the money supply, so that finally the larger supply of money 
will have brought with it no permanent increase in the number 
of exchanges. 

The conditions under which general price changes resulting 
from an increase in the quantity of money occur in actual life 
are much more complex, and yet there is no reason to suppose 
that in its fundamentals the process is essentially unlike that 
which we have just outlined. There is, however, the difference 
that additions to the supply of money usually find their way at 
first into bank reserves, where their immediate effect is to lower 
the discount rate. This leads to increased bank lending and 
to larger bank deposits, and the immediate purchasing power 
of the community, in the form of its power to draw bank checks, 
is correspondingly increased. Increased purchases will be 
made, and so far as the immediate effect upon prices is con- 
cerned, it is immaterial that a large part of the increase may be 
in purchases of labor, raw materials, and supplies, i.e. in expen- 
ditures for " productive " rather than for " final " consump- 
tion. Prices must rise, and this will draw a larger amount of 
money into hand-to-hand circulation. With higher prices 
people will find it convenient to keep somewhat larger amounts 
of money on hand as " pocket-money." Finally, unless new 
disturbing factors appear, equilibrium will be reached between 
the amount of money in bank reserves and the amount of money 
in hand-to-hand circulation. It seems probable, then, that 
the sequence of processes by which an increase in the supply of 
money actually brings about a general increase in prices may 
often be (i) larger bank reserves, (2) lower discount rates, 
(3) larger bank deposits, (4) more purchases, (5) higher prices, 
(6) more money drawn into hand-to-hand circulation. Prices 
get their initial upward impetus from the larger bank re- 
serves, but the increase in the amount of money in hand-to- 



OTHER PROBLEMS IN MONEY AND BANKING 327 

hand circulation helps to support and maintain the higher 
price-level.^ 

Thus far, however, we have neglected to take account of the 
very important facts, (i) that gold has other than monetary 
uses, (2) that the production of gold will itself depend in part 
upon its purchasing power, and (3) that international gold ship- 
ments are also partly dependent upon the relative purchasing 
power of money in one country and another. Leaving the last 
of these three topics for treatment in the following chapter in 
connection with the general subject of international trade, we 
pass now to the discussion of the other two. 

The Relation of the Industrial Uses of Gold to Prices. — 
From the estimates of the Director of the Mint it appears that 
in recent years from one fourth to one third of the world's 
annual production of gold finds its way into industrial uses. 
The United States mints and assay offices refine nearly all the 
crude gold bullion produced in or brought to this country, 
and allow the depositor to take the proceeds in money or in 
bars of gold for industrial use, as he prefers. But even without 
this convenient arrangement there would be a constant balanc- 
ing or comparison of the relative advantages of the industrial 
and monetary uses of gold. The number of dollars which can 
be got by selling gold for money and by actually converting 
gold into money must, of course, always be approximately 
equal. 

More than that, there are two things quite distinct from 
the direct process of selling gold bullion for money which help to 
fix the ratios of exchange between gold and other things. Con- 
sumers, on the one hand, are constantly weighing the marginal 
utility of objects made from gold against the marginal utility 
of other things. Producers, on the other hand, are weighing 
the relative profitableness of producing things made from gold 
and things made from other materials. It is clear that gold will 
be distributed between its industrial and monetary uses in such 
a way as to equalize the exchange ratios of gold and other 

1 Cf. the testimony of Professor Alfred Marshall before the British Gold and 
Silver Commission of 1888, in Appendix to Final Report, p. 3. 



328 OUTLINES OF ECONOMICS 

things for the two uses.^ If, for example, an increase in the 
stock of money (whether gold or not) results in increased prices 
(i.e. in decreased purchasing values of gold), a relatively larger 
amount of the gold annually brought to the mints will tend 
to flow into industrial uses, and thus to limit the increase in the 
amount of money and the consequent rise in prices. 

The Relation of the Expenses of Gold Production to Prices. — 
There is another way in which society makes direct compari- 
sons between the value of gold and the value of other things. 
Mining, like agriculture, is subject to the law of increasing 
expenses, and the tendencies of prices to equal the maximum 
expenses of production per unit holds true for both indus- 
tries. Not only are there marginal mines, mines which it just 
pays to operate, but in the most productive mines there are 
margins, — certain depths, for example, beyond which the 
expense of mining more than eats up the value of the product. 
Through the operators of mines, societ}^ is continually compar- 
ing the cost in labor and capital of the production of gold with 
the cost, similarly measured, of the things that can be bought 
with the produced gold. If the gold produced at the margin 
will purchase things which consumers deem of less importance 
than other things which might have been produced with the 
use of no more capital and labor, capital and labor will grad- 
ually be shifted from their marginal use in gold mining to the 
production of other things. Here, then, as in the case of the 
balancing between the monetary and industrial uses of gold, 
we have a direct value-comparison of gold and other things. 

Some years ago the Bureau of the Mint undertook an investi- 
gation into the relation of the expense of gold mining to the 
amount of gold produced. The conclusion reached is worth 
quoting in this connection : 

In every mining district there are mines producing at good profits, mines 
producing at small profits, mines barely paying expenses, and mines oper- 
ated at a loss, but with the hope that they will do better. Every increase 
in costs would submerge the latter more deeply, add to the list of the un- 

1 The expense of transforming bullion into jewelry, etc., is left out of account, 
as it does not affect the principle under consideration. 



OTHER PROBLEMS IN MONEY AND BANKING 329 

profitable, and probably close some of them. ... A higher scale of work- 
ing costs will bring losing experiments to an earlier conclusion, reduce profits, 
and make mining ventures generally less attractive, and thus diminish the 
output.^ 

To summarize : Marginal utilities and subjective values are 
found in the industrial uses of gold. The particular form of the 
law of normal price that is operative in agriculture also holds 
true in gold mining (although it has to be stated in a somewhat 
different way). An increase in the supply of gold diminishes its 
marginal utility in industrial uses. This is bound to decrease 
the values of gold as money, on account of the ease with which 
the supply of gold can be shifted to one use or the other. Such 
a rise of prices, however, cannot continue indefinitely. The 
increase of prices and wages brings increasing expenses in 
gold mining, and, unless new gold mines are found or cheaper 
ways of getting gold from old mines are invented, the output 
of gold will have to decrease. 

These things have a steadying influence upon prices. Tend- 
encies toward extreme fluctuations in prices are held in check 
by the resulting changes in the expense of mining gold and by 
the automatic changes in the proportions of the annual gold 
product that flow into monetary circulation and into industrial 
uses. It is in these ways that the significance of the fact that 
the monetary standard is itself a commodity appears. 

The Increase in the Production of Gold. — Although prob- 
ably more gold was produced between 1850 and 1875 than from 
1492 to 1850, yet, as Table I shows, the annual production of 
gold since 1896 has been from two to three times as large as it 
was between 1850 and 1875. Most of this great output of gold, 
as Table II indicates, comes from relatively few countries. 
At present the British empire supplies over one half and the 
United States (including Alaska) nearly one fourth of the total 
product. The causes of this enormous increase were, in part, 
the opening up of new gold fields in South Africa, Canada, 
Alaska, and Colorado, and in part the improvements in methods 
of extracting gold from low grade and refractory ores, in which 

1 Report on the Production of the Precious Metals, 1904, p. 41. 



330 OUTLINES OF ECONOMICS 

TABLE I 

Production of Gold in the World since 1841 

(From 1841 to 1885 the estimate is from a table of averages for certain periods, 
compiled by Dr. Adolph Soetbeer; for the years 1886 to 191 2 the production is the 
annual estimate of the Bureau of the Mint.) 





Annual Average for Period 


Period 








Fine Ounces 


Value 


1841-1850 


1,760,502 


$ 36,393,000 


1851-1855 


6,410,324 


132,513,000 


1856-1860 


6,486,262 


134,083,000 


1861-1865 


5,949,582 


122,989,000 


1866-1870 


6,270,086 


129,614,000 


1871-1875 


5,591,014 


ii5~,577,ooo 


1876-1880 


5,543,110 


114,586,000 


1881-1885 


4,794,755 


99,116,000 


1886-1890 


5,461,282 


112,895,000 


1891-1895 


7,882,565 


162,947,000 


1896-1900 


12,446,939 


257,301,100 


1901-1905 


15,603,730 


322,619,800 


1906-1910 


20,971,575 


433,520,900 


1911 


22,348,313 


461,939,700 


1912 


22,549,335 


466,136,100 



TABLE II 

Recent Production of Gold in Different Countries' 



Country 


1897 


1900 


1904 


Africa 


88 

97 
86 

35 

9 

12 

II 

9 
26 


13 
III 
119 

31 

42 

14 

13 

8 

35 


129 

132' 

121 

25 
18 


Australia 


United States and Alaska 

Russia 

Canada 

British India 


Mexico 

China 

All others 


19 

7 
35 




Total 


355 


385 


523 



* From Journal of Folitical Economy, vol. x, p. 580, and Finance Report, 1907, 
p. 363. The figures are given in thousands of kilograms. 



OTHER PROBLEMS IN MONEY AND BANKING 33 1 

connection the development of the " cyanide process " has 
been of special importance.^ Dredging for gold in the beds of 
rivers which drain gold-yielding lands, is a very recent devel- 
opment of considerable importance. Notwithstanding the de- 
crease in the value of gold, the bulk of the gold produced in 
California today is from ore bodies that twenty-five or thirty 
years ago were generally considered worthless. 

The effects of this enormous output have been felt in both 
Europe and America in a general increase of both prices and 
wages. There are some who expect that the values of gold will 
continue to depreciate for a long time in the future. Account 
must be taken, however, of the automatic check which the 
increase in wages and prices is bound to put on the production 
of gold by increasing mining expenses. On the other hand, 
still further economies in productive methods are possible. 

Some Economic Effects of Changes in the Values of Money. 
— We have seen that an increase in the amount of money 
available for bank reserves leads to the expansion of credit, 
stimulates business, and increases prices. The same results 
are achieved, although in not the same way, by a sudden debase- 
ment of the standard of value, or by the introduction of irre- 
deemable paper money as the medium of exchange. Prices 
are gradually increased under such conditions, there being an 
unmistakable tendency to adjust them to the change in the 
" dollar " or other unit of the medium of exchange.^ The 
rising prices stimulate business by increasing profits. Profits 

1 "There are many mines in operation now at a profit which could not have been 
worked at a profit ten years ago. There has been an important addition to the 
gold and silver product by the recovery of these metals from lead and copper ores 
by modern processes. The most important gains seem to have come, however, 
through economies in management, particularly by enlarging the scale of operations 
and by more complete extraction of the values from the ores treated." — Report on 
the Production of the Precious Metals, 1904, p. 41. 

2 Possibly the effect upon other prices of the increased prices (measured in the 
depreciated money) that have to be paid for imported commodities and that are 
received for exported commodities is the key to this problem, just as it was undoubt- 
edly the chief cause of the rise of prices to fit the bulhon value of coins from which 
seigniorage had been taken. This is the explanation of the rise of prices under 
the greenbacks suggested by Professor W. C. Mitchell, the historian of that move- 
ment. 



332 OUTLINES OF ECONOMICS 

are increased because most of the expenses of production are 
incurred before the goods are sold, so that the rise in prices 
increases the margin between prices and the expenses of pro- 
duction, and because, moreover, some of the expenses of pro- 
duction do not usually rise as rapidly as do prices. An expan- 
sion of business activity of the kind already described is apt to 
be the result, and this is not generally soon restrained by in- 
sufficient bank reserves, for depreciated money is usually, 
though not always, money that is coined or issued in large 
quantities. 

That periods of prosperity induced in this way are inevitably 
short-lived and usually end in severe crises does not make them 
any the less real. Nor should the fact that such artificial condi- 
tions of business enterprise are apt to be accompanied by exces- 
sive speculation and other unhealthy features blind us to the 
fact that they accomplish some good. The encouragement 
given to venturesome undertakings leads to the trial of new 
methods of production, to the development of new natural 
resources, to undertakings of vast proportion, to a general free- 
ing of industrial organization and methods from the restraints 
of habit and tradition. The foundations of modern large-scale 
industry in the United States were laid in the. period between 
the Civil War and the panic of 1873. The period of state bank 
note inflation preceding the panic of 1837 was a period in which 
the industrial map of the United States was almost wholly 
changed, and, in the long run, for the better. 

A rapid increase in the supply of standard money may have a 
similar effect. A tremendous expansion of international trade 
followed the gold discoveries in California and Australia. In 
the sixteenth century, increases in the supply of the money 
metals, historians are agreed, hastened the fall of the medieval 
economic system. The almost unparalleled development of 
industry and industrial organization in the United States since 
1897 must, with its good features as well as its bad, be at- 
tributed in part to the increased supply of gold. 

Business prosperity, however, does not always coincide with 
the real economic welfare of the masses of the people. If 



OTHER PROBLEMS IN MONEY AND BANKING 2>33 

prices are rising faster than money wages, real wages are ob- 
viously declining. A period of falling prices is very apt to be 
a period of increasing well-being for those whose incomes are 
wages or salaries, although here we have to remember that 
even if daily or weekly wages do not fall so rapidly as prices, 
an increase of unemployment may affect total yearly incomes 
adversely. 

Crises. — Crises are frequently recurring phenomena of cur- 
rent economic life. They are of all degrees of severity, but 
are generally characterized by a scarcity of bank credit, a 
sudden drop in prices, a subsequent period of industrial depres- 
sion, lack of employment for wage earners, and kindred symp- 
toms. 

Crises are frequently attributed to " over production," or, 
when that expression is criticized (because human wants are 
never fully satisfied) to " under consumption." The two ex- 
pressions are different ways of describing the same thing, and 
both are misleading because they put the emphasis in the wrong 
place. Production and consumption have to do with quanti- 
ties of things and their fitness to satisfy human wants. Crises 
spring from mishaps in the price process ; they relate to what 
might be called the dollars and cents aspect of economic life. 
It is difficult, even impossible, for observers to analyze all the 
factors entering into a particular crisis, and it is even more 
difficult to formulate a theory of crises that will be of general 
applicability. There are some important things about crises, 
however, that are relatively well known, and these will form 
the basis of our discussion. 

It is a significant fact that crises generally occur only as sharp 
interruptions of periods of business prosperity, when credit is 
abundant, prices relatively high, and employment plentiful. 
Whatever may be the cause of a period of exceptional business 
prosperity, it is apt to contain within itself the seeds of its own 
destruction. The point will appear clearly if we put together 
two conclusions that were reached in the preceding chapter : 
first, that the supply of loanable funds in the form of bank 
credit is a function of two variables, — the supply of personal 



334 OUTLINES OF ECONOMICS 

credit and the supply of money available for bank reserves; 
second, that personal credit is based on the probable amount 
of future money incomes and probable future prices of property. 
Suppose, for example, that business conditions are pros- 
perous and promise to continue so, and that there is a plentiful 
supply of money in the bank reserves. Expected prices and 
expected profits are large, expected interest payments seem 
certain. The power to get this future income depends, how- 
ever, upon the possession of land, capital goods, franchises and 
other privileges, the established business relations that give 
rise to " good- will values," or upon the possession of income- 
yielding securities, such as mortgages, bonds, stocks, etc. 
Under such conditions, these things command good prices in 
the market and may easily be hypothecated, either formally or 
implicitly, in order to secure purchasing power, — bank credit. 
The bank credit thus created is put into further investments 
of capital and into the creation of further business opportunities. 
These things serve in turn, so long as their income-yielding 
power seems certain, as the basis of further extensions of bank 
credit, and thus the process of business expansion continues 
in a cumulative fashion. Overproduction, it is true, is present, 
but it is the overproduction of the means of production and of 
acquisition, — of railways, factories, and business schemes, — 
and it is accompanied by the overappraisal, the overcapitaliza- 
tion, of these things. An extensive period of increasing pros- 
perity of this kind is, however, scarcely possible unless the 
supply of money is increasing ; for bank reserves as well as the 
amount of expected personal incomes condition the supply of 
purchasing power. Very often, in fact, it may be a sudden 
increase in the supply of money available for bank reserves that 
gives the initial impetus to the rapid expansion of business. 
Larger reserves, lower discount rates, larger investments, an 
increased volume of trade, is as we have seen, the normal 
sequence in such cases. Periods of rising prices are periods of 
rising profits, for fixed charges, the rate of interest (even on 
new borrowings), and wages do not usually rise as rapidly as 
prices. These rising profits are, of course, the direct cause of 



OTHER PROBLEMS IN MONEY AND BANKING 335 

the overinvestment in production goods and the overcapitaliza- 
tion of business opportunities. 

Aiiy one of a number of things may be sufficient to precipitate 
a panic under such conditions. The whole business structure 
may fall to pieces through sheer topheaviness. That is, so much 
production today is indirect, so large a share of productive 
effort is devoted to forwarding in indirect ways the production 
of goods that will be ripe for human use only in the compara- 
tively distant future, that the mere operations of supply and 
demand among business men themselves may maintain pros- 
perous business conditions for some time. But in the long run 
the maintenance of the values of producer's goods and privi- 
leges depends on the demand, and hence on the income, of 
ultimate consumers. Wages do not usually rise as rapidly as 
prices in periods of business expansion. This simple fact may 
in itself keep the average purchasing power of consumers 
from expanding rapidly enough to furnish a solid support for the 
growing structure of capital values. 

Crop failures may precipitate a panic by diminishing the pur- 
chasing power of those engaged in agriculture, and, possibly, by 
reducing exports and thus necessitating the taking of gold from 
the bank reserves to ship to Europe in payment for our imports. 
When the credit situation is at all strained, the failure of one im- 
portant bank may be enough to precipitate a panic. The bank's 
creditors are prevented from meeting their own obligations ; 
the solvency of others is in turn dependent upon them, and thus 
losses in expected and often already hypothecated income are 
transmitted from firm to firm and from industry to industry 
in a constantly widening circle. The reduction of bank re- 
serves by reason of the flow of money into hand-to-hand cir- 
culation in order to effect exchanges at the higher level of prices 
may itself be a contributing cause of a panic. 

In fact, whatever may be the immediate cause of a panic, it is 
bound to grow, in a condition of inflated capital values, with 
tremendous rapidity. The collapse of credit leads to forced 
sales of property in order that credit obligations may be met. 
These reduce prices, lessen the security on which credit is 



336 OUTLINES OF ECONOMICS 

founded, and render banks less able and less willing to make 
loans. Moreover, the hoarding of money, which is apt to be a 
feature of a panic, has a destructive effect on bank reserves. In 
a serious panic the liquidation of obligations has to work itself 
out. Then the industrial process starts afresh, with lowered 
values imputed to capital goods and to business opportunities, 
and with property rights shifted, in some measure, to creditors. 

Crises seem to be unpreventable so long as competition and 
the credit system dominate in industry. Yet there are some 
recent developments that may make them less frequent, and 
possibly less serious. 

The " integration of industry," whereby a whole series of pro- 
ductive processes, from the production of the raw material to the 
sale of the finished product, are brought together under one 
management, decreases the number and complexity of credit 
relations between producers, and tends to prevent the Undue 
expansion of those parts of the productive process that are 
farthest removed from the consumer. The strong position of 
the steel industry in the United States is a case in point. The 
improvements in the bargaining power of wage earners result- 
ing from their organization have enabled them partly to pre- 
vent the widening of the gap between wages and prices in pros- 
perous times, as recent American statistics show. On the 
other hand, crop failures are and always will be a factor of 
uncertainty. The best way of softening the rigors of a panic 
and of restoring normal conditions promptly is through a wise 
use of the lending power inherent in a system of really elastic 
bank reserves, just as the best way of preventing panics is 
through a firm control of discount rates when all other condi- 
tions are ripe for a period of business inflation. It is in these 
ways, perhaps, that the new federal reserve system can best 
serve the country. 

The Standard of Deferred Payments. — The relation of 
changes in the purchasing power of money to long-time debts 
and credits has some very important aspects. If prices increase, 
the principal of a loan represents less purchasing power at the time 
of repayment than at the time the loan was made. If prices 



OTHER PROBLEMS IN MONEY AND BANKING 337 

decrease, the reverse is, of course, true. In periods of cheap 
money agitations the additional burdens imposed upon debtors 
in a period of decreasing prices are emphasized. An important 
function of money, then, is found in its use as a standard of 
deferred payments. 

There is a partial, but only partial, compensation for the in- 
justice to debtors and creditors resulting from general changes 
in prices in the fact that the interest rate usually increases 
when prices increase and decreases when prices decrease. This 
is largely because rising prices increase profits, thus inducing 
business men to pay higher interest rates in order to secure larger 
supplies of funds for investment ; while falling prices decrease 
profits and lessen the demand for loanable funds. The result 
of this is that the changing purchasing power of the principal 
of a loan is to some extent offset or discounted by changes in 
the rate of interest. The decline in interest rates as prices fall 
makes it possible for debtors to pay off their old obligations with 
funds borrowed at a lower rate of interest. Creditors cannot 
so easily take advantage of the fact that interest rates are in- 
creasing when the purchasing power of the principal of their 
outstanding loans is decreasing. Nevertheless, more emphasis 
has been given to the question of the standard of deferred pay- 
ments in periods of declining prices, when debtors are in- 
juriously affected, than in periods of rising prices, when credi- 
tors are the losers. The United States is rapidly ceasing to be 
a " debtor nation," and the farmers, in particular, are becom- 
ing less distinctively a " debtor class." We may expect, 
therefore, that in a future period of declining prices we shall 
hear less about the injustice of our variable standard of deferred 
payments. 

Index Numbers. — General changes in prices are indicated 
statistically by the use of index numbers. An index number, 
in the most general sense, is some magnitude which varies with 
some other magnitude or complex of magnitudes, and whose 
variations can therefore be taken as representing or indicating 
the other variations. In studying the variations of the price 
of some specific thing we need no index number ; but when we 



338 OUTLINES OF ECONOMICS 

have to deal with the variations of many different prices, we 
find the use of index numbers necessary. 

The simplest way to form an index number of general changes 
in prices is, first to select a list of things whose prices are to be 
taken into account, next to ascertain the average price per 
unit paid for each of these things in each successive month or 
year of the period being studied, and finally to take the sum of 
these unit prices in each of a number of successive months or 
years as the index numbers. Such index numbers show the 
variations in the total expense of a purchase consisting of one 
unit each of the commodities included in the list. Thus if 
bananas of a certain grade sell at a certain time for 15 cents a 
dozen, oranges at 40 cents, and peaches at 25 cents; and if a 
month later the prices are 20 cents for bananas, 50 cents for 
oranges, and 20 cents for peaches, the summed prices used as 
index numbers are 80 cents and 90 cents respectively." This 
means merely that the total money cost of a dozen each of these 
fruits has increased by i2|- per cent. 

For some purposes we get more significant results by weight- 
ing the specific prices in accordance with the relative impor- 
tance of the different commodities. If, for example, we think 
that twice as many bananas as peaches are ordinarily used, and 
three times as many oranges as peaches, we may take as our 
weighted sum at the earlier date, .25 plus (2 X .15) plus (3 X .40), 
or $1.75. For the later date the weighted sum is $2.10, indi- 
cating a general rise of 20 per cent in the retail prices of this 
small group <of commodities. Accurate weighting is thus of 
great importance in forming index numbers from a small list 
of price quotations. If a very large list of prices is used, weight- 
ing becomes of less importance, for there is no necessary con- 
nection between the importance of a commodity and the 
degree to which it has risen or fallen in price. Errors due 
to the lack of weighting or to imperfect weighting thus 
tend to offset each other. But even with a large and 
thoroughly representative list of prices, the highest degree of 
accuracy in index numbers cannot be reached without careful 
weighting. 



OTHER PROBLEMS IN MONEY AND BANKING 339 

Index numbers are, however, more often constructed as 
averages than as sums. Thus the ordinary arithmetic averages 
of the prices of these kinds of fruit at the two dates are .80 -;- 3 
and .90 -j- 3, or .27 and .30 respectively. The weighted arith- 
metic averages are 1.75 -i- 6 and 2.10 -^ 6, or .29 and .35. 
The averages, of course, indicate the same proportionate gen- 
eral change in prices as do the sums, but when the price list is 
large the use of the average makes the series of price changes 
somewhat more easy to inspect and interpret. 

It is a common practice in making index numbers to substi- 
tute relative prices for actual prices before summing or averag- 
ing them. The price of each commodity at each date is set 
down as a per cent of its price at some one specific date (or of its 
average price during a certain period). Thus, in the illustra- 
tion already given, if we use the earlier date as the " basing 
period," the price per dozen of each kind of fruit is set down as 
100. The relative prices in the later period then are : bananas, 
133; oranges, 125; peaches, 80. This gives an unweighted 
sum of 338, and an unweighted arithmetic average of 113, 
indicating an average relative change in prices of 13 per cent. 
Relative prices may also, of course, be combined by means of 
weighted sums and averages. Index numbers utilizing relative 
prices should be constructed and interpreted with great cau- 
tion, because the results will vary according as one period or 
another is used as the basing period. If, for example, in the 
illustration already given, prices at the later date are used as the 
basing prices, average relative prices at the earlier date become 
93, indicating an average increase of only a little over 7 per cent 
instead of the 13 per cent indicated when the earlier prices 
were used as bases. When a large price list is used this particu- 
lar source of error becomes of less (though not of negligible) im- 
portance. But there remains the difficulty that for periods 
remote from the basing period this method exaggerates a rise in 
prices and understates a fall.^ It is accordingly sometimes de- 
sirable to use chain index numbers, in which the relative prices 

1 This grows out of tHe fact that a price cannot fall by more than 100 per cent 
but can rise without definite limit. 



340 OUTLINES OF ECONOMICS 

for each successive period are stated or expressed as per cents 
of the prices in the period immediately preceding. That is, 
the base is repeatedly shifted from one period to the next. 

In constructing an index number from relative prices, other 
kinds of averages than the ordinary arithmetic average may 
sometimes be wisely used. The median relative price is the 
one which divides all of the relative prices for a given date 
into halves, — one half being lower and one half higher than 
the median. The median is easy to find and easy to interpret. 
Less used are the mode, — the relative price that occurs most 
frequently at a given date, and therefore shows what is in a 
way the most " characteristic " price change, — and the geo- 
metric average, — the nih root of the relative prices of n com- 
modities. The geometric average has a number of advantages. 
It gives less weight to extreme price variations than does the 
arithmetic average ; geometric averages of relative prices show 
just the same general price changes as geometric averages of 
actual prices; and the results obtained are alike whether one 
date or another is chosen as the basing period. It is, in prin- 
ciple, the correct average to use when the problem is not that 
of finding the change in the aggregate purchasing power of 
money, but the (mathematically) different problem of finding 
the general change in the different ratios of exchange between 
money and other things. 

In general, whether one kind of index number is better than 
another usually depends upon the character of the available 
data and the use that is to be made of the results. For example, 
if the problem is that of measuring the change in the cost of 
living of the laboring classes, the best index number is a sum or 
average of actual prices, weighted in accordance with the rela- 
tive importance of the different items in the expenditures of 
t)rpical laboring-class families. Sometimes changes in prices 
bring about such changes in the relative amounts of different 
things purchased that if, for example, we are comparing the 
cost of living in two periods rather far apart, we shall get differ- 
ent results according as we weight our index numbers in accord- 
ance with expenditures in one period or the other. 



OTHER PROBLEMS IN MONEY AND BANKING 341 



TABLE III 

Index Numbers of Wholesale Prices, Wages, and the Cost of 
Living in the United States: i8go-i9i2 



Year 



1893 
1894 

189s 
1896 
1897 
1898 
1899 
1900 
1901 
1902 
1903 
1904 

190S 
1906 
1907 
1908 
1909 
1910 
1911 
1912 



Wholesale 
Prices ^ 



112. 9 

III. 7 

106. 1 

105.6 

q6.i 

93-6 

90.4 

89.7 

93-4 
101.7 
110.5 
108.5 
112. 9 
113-6 
113.0 

iiS-9 

122.5 

129.5 
122.8 
126.5 
131-6 
129.2 
133-6 



Wages 2 



100.2 

100.5 

101.8 

101.6 

96.7 

98.2 

99.0 

99-3 

99-6 

103.0 

107.0 

no. 2 

114.4 

119. 8 

122.6 

125-5 
132.0 

137-1 
I33-S 
132.9 

137-6 
141.0 
I4S-2 



Cost of Living ' 



105.6 
105.8 

103 -7 
104.6 

98-3 

96.0 

94-6 

94-7 

97-1 

99-5 

105.3 

107.5 

112. 6 

114-5 
115.0 

"5-3 
120.0 
125.8 
125.4 
130.0 
135-2 
133-3 
141. o 



^Bulletin of the United States Bureau of Labor Statistics, No. 173, p. 126. An 
unweighted arithmetic average of the (relative) average yearly wholesale prices 
of about 240 commodities. Price quotations used are so chosen as to constitute 
in themselves a rough and unsystematic weighting. Average actual prices from 
i8go to 1899 are used as bases. 

2 From W. I. King, The Wealth and Income of the People of the United States, p. 
195. Weighted average of the relative average wages per hour for male wage earners 
in various manufacturing industries, railroad transportation, mining, and agri- 
culture. By reason of paucity of data these index numbers and those of the cost of 
living are subject to wider margin of error than those for wholesale prices. The 
basing period includes the years from 1890 to 1899. 

3 From King, op. cit., p. .180. A weighted average of statistics for (i) retail 
prices of food, (2) cost of fuel and light, (3) cloth and clothing, (4) house furnishing 
goods, and (5) miscellaneous items. Relative prices are used throughout and are 
per cents of average prices in the period from 1890 to 1899. 



342 OUTLINES OF ECONOMICS 

It is often important to know the distribution as well as the 
general trend of price changes. The range of variation of the 
different relative prices might, for example, be comparatively 
large above the average and comparatively small below it. 
These are various ways of measuring and stating the distri- 
bution of price changes but their adequate consideration would 
lead us into matters too technical for discussion here. The 
whole matter of index numbers is full of subtle difi&culties, some 
of them mathematical, but more of them demanding primarily 
a clear-headed analysis of the economic problems involved. 

Index numbers of prices and wages are available for the 
United States for the period since i860, and some figures have 
been compiled for earher years. For the period 1 860-1 880 
Mitchell's^ are the best; the period from 1890 to the present 
is covered by the United States Bureau of Labor Statistics - and 
for the gap from 1880 to 1890 Falkner's are available.^ Several 
financial journals also publish tables of price changes.^ 

Some writers have suggested the possibility of a tabular mon- 
etary standard, to be maintained by frequently changing the money 
unit in accordance with the showings of an officially kept sys- 
tem of index numbers. To do this by periodically altering the 
amount of bullion in standard coin would be impracticable,^ 

1 In his Gold, Prices, mid Wages under the Greenback Standard. 

^ In various numbers of the Bulletin of the Bureau of Labor Statistics. 

3 In "Aldrich Report" on Wholesale Prices, Wages, and Transportation, Senate 
Doc, 32d Cong., 2d Session, No. 1304. 

■* For an account of modern index numbers of wholesale prices see Bulletin of the 
Bureau of Labor Statistics, No. 173 (July, igis), Part ii. 

^Professor Irving Fisher has suggested that the dollar might be "stabihzed" 
by making the real monetary standard a variable amount of gold bullion. Accord- 
ing to his plan, gold coins of the present weight might be retained, but if the olEcial 
inde.x number should show advancing prices, the mint price (in gold bullion) of gold 
coins would be slightly increased and at the same time the gold coins in circulation 
would be made redeemable at the treasury in (nearly) as much gold bullion as con- 
stitutes the increased mint price of the coin. If prices show a continued tendency 
to increase, the gold dollar would virtually become a gold certificate for a consider- 
ably larger amount of gold bullion than it contains. This plan could be so oper- 
ated. Professor Fisher beheves, as practically to eliminate general price changes. 
It is clear that no one nation could introduce such a plan, because it would cause 
highly objectionable fluctuations in the price of foreign exchange and in the domestic 
prices of imported goods and of important exports. It could be adopted for inter- 



OTHER PROBLEMS IN MONEY AND BANKING 343 

while to abandon the use of a standard commodity and to 
attempt to regulate prices by issuing fiat money and controlling 
the amount in circulation would be, as we have seen, chimerical. 
A tabular standard of deferred payments might be put in opera- 
tion by laws providing for the increase or diminution of the 
principal of debts according to changes in prices. It is prob- 
able, however, that this would be satisfactory to neither debtors 
nor creditors. Moreover, should the tabular standard of 
deferred payments be adjusted according to changes in the 
prices of commodities, or according to changes in wages and 
other incomes, or according to general changes in the prices of 
commodities and services ? The really essential thing is to have 
a commodity standard of value that shall be as stable as pos- 
sible, and to maintain the convertibility of all other forms of 
money with it. With gold as the standard of value, and with 
all other forms of money redeemable in gold, changes in prices 
are not apt to be rapid enough to work much injustice to either 
debtor or creditor. The compensating influence of changes 
in the interest rate must also be taken into account. The ques- 
tion of the grievances of debtors and creditors has been over- 
emphasized as compared with the really important economic 
problems growing out of general changes in prices. These are, 
as we have seen, first the effect on business enterprise, and 
second, the effect on the purchasing power of money wages 
and other forms of money incomes. 



QUESTIONS 

1. Construct simple index numbers for wholesale prices, in one city, 
covering a period of a few weeks. (Use the market quotations in a daily 
paper as data.) 

2. How should one construct index numbers that would show the fluctua- 
tions of P, in the equation of exchange? 

3 . If half the money in the world were destroyed, would prices be doubled ? 
If half the gold in the world were destroyed ? 

national use, as Professor Fisher shows, in the form of a (variable) gold-exchange 
standard. But there are many practical difiSeulties in the way of such a change. 



344 OUTLINES OF ECONOMICS 

4. Would an increase of $1,000,000,000 in bank notes have the same 
effect on prices in this country as the importation of $1,000,000,000 in 
gold? 

5. Explain the mechanism by which a decrease in the quantity of money 
affects prices. 

6. Report on the changes of prices, of bank reserves, and of bank deposits 
accompanying the crises of 1893 and 1907. 

7. Report on the socialistic explanations of crises. 

REFERENCES 

(See also references for Chapters XIV and XV.) 

Davenport, H. J. The Economics of Enterprise, Chaps, xvi, xvii. 

De Launay, L. The World's Gold. 

Fisher, Irving. The Purchasing Power of Money; Why the Dollar is 
Shrinking. 

Jones, E. D. Economic Crises. 

Kemmerer, E. W. Money and Credit Instruments in their Relation to 
General Prices. 

Mitchell, W. C. Business Cycles; "The Making and Using of Index 
Numbers," Bulletin of the U. S. Bureau of Labor Statistics, No. 173. 

Moore, H. L. Economic Cycles. 

Veblen, Thorstein. The Theory of Bitsiness Enterprise, Chap. v. 

Walsh, C. M. The Measiirenient of General Exchange Value; The Funda- 
mental Problem in Monetary Science. 



CHAPTER XVII 
INTERNATIONAL TRADE 

The supply of gold, the development of trade, money, bank- 
ing and credit, in short all the economic forces and institutions 
discussed in the chapters immediately preceding, take on special 
complexity when they become international in scope. The 
fundamental principles underlying international trade and credit 
are the same as those underlying domestic trade and credit — a 
truth too frequently forgotten — but trade between two coun- 
tries in which language, banking institutions, monetary units, 
and monetary legislation are different presents special problems 
which call for separate treatment. 

Foreign Exchange. — In the beginning a brief description 
must be given of the mechanism of foreign exchange. In in- 
ternational as in domestic trade, only a small amount of money 
is used, compared to the enormous money values of the goods 
exchanged. Purchase is set against sale, debt canceled by 
credit, and money is employed only for the occasional settlement 
of balances. This cancellation of offsetting claims is effected 
by the banks and bankers who engage in foreign exchange. 
Their work is indispensable in the development of foreign trade. 
The European War, for instance, by interrupting traffic between 
Europe and South America opened up large export possibilities 
to American manufacturers; but it was found impossible to 
take large or immediate advantage of this opportunity, partly 
because the necessary banking and credit connections had not 
been established between South America and this country. 

As illustrative of the processes of foreign exchange, let us take 
our trade with England. Ordinarily, an American exporter 
who has sold goods to England draws an order — a bill of ex- 
change — on the English debtor, directing him to pay the claim 

345 



346 OUTLINES OF ECONOMICS 

at some specified time and place in London. American im- 
porters, on the other hand, commonly pay their foreign balances 
by buying bills of exchange or drafts on London, and sending 
them to their English creditors. In this way American debts 
and credits are balanced in London without transferring any 
money at all, except occasionally ^ to settle the balance of in- 
debtedness. • 

Bills of exchange drawn on a commercial debtor are usually 
accompanied by bills of lading, insurance receipts, certificates 
of weight and origin, and all the documents necessary to give 
the purchaser of the bill full title to the goods until the bill is 
accepted or paid. They are accordingly referred to as " docu- 
mentary bills " or " commercial bills," to distinguish them from 
" bankers' bills " and other instruments of international credit 
described hereafter. Documentary bills are freely negotiable, 
passing from hand to hand by indorsement, and gathering 
strength with each new indorsement. It is important, also, 
to note the difference between " sight bills " and '' long bills," 
the former calling for payment upon presentation, the latter 
usually for immediate " acceptance " by the drawee ^ and pay- 
ment after thirty, sixty, or ninety days. The price of long bills 
is fixed by the price of sight bills and the discount rate in 
London. 

We may now enlarge our simplified illustration to something 
like life size. Documentary bills drawn by exporters or creditors 
all over the country are sold by the drawers to bankers, usually 
New York bankers, who may be called the " wholesalers of 
exchange." The sale may be either direct or through exchange 
brokers, " the jobbers of exchange." These documentary bills 
are sent by the New York banks to their foreign correspondents 

1 "Acceptance" of a bill definitely obligates the acceptor to pay it. Many im- 
porters arrange to have bills drawn upon them accepted by some bank, protecting 
the accepting bank by a deposit of collateral and paying it a commission for 
its services. Bills accepted by banks ("bankers' acceptances") command a very 
low rate of discount, and are for many reasons very desirable elements in an "open 
discount market." The federal reserve banks are seeking to develop the use of 
bankers' acceptances in the United States. National banks are now empowered 
to accept bills of exchange originating in foreign trade. 



INTERNATIONAL TRADE 347 

for collection (in the case of sight bills) or acceptance (in the 
case of long bills). The balances thus built up abroad by the 
New York banks constitute the fund against which they draw 
their own bills. These are sold directly or through smaller 
banks — the " retailers of exchange " — located in all parts of 
the country. Foreign exchange is sold in a great variety of 
forms — bankers' drafts, travelers' checks, travelers' letters of 
credit, commercial letters of credit, cable transfers, and the 
like — descriptions of which may be found in the references 
given at the end of the chapter. 

The illustrations used above, while typical of a large part of 
the foreign exchange of this country, fail to represent adequately 
the complexity which marks some of the interactions of inter- 
national credit. An illustration of the more complex class is 
found in the " three-cornered " or " triangular exchange." 
We import from, very much more than we export to, South 
America. A part of the debit balance — though possibly not 
the larger part at the present time — is settled by the transmis- 
sion of London drafts to our South American creditors, who can 
use them advantageously in the settlement of their debts in 
Europe. Our rate of exchange with any particular foreign 
country is therefore controlled not by our trade with that 
country, but by our dealings or general balance with the rest 
of the world ; and London " clears " for the world as New 
*York " clears " for America and Paris for France. Just as 
the net balance of our domestic trade is struck in New York, 
so final international balances are cleared or settled in London, 
although London's preeminence in international exchange is not 
now so striking as it has been in the past. The European war 
transferred, for the time being at least, a considerable amount 
of this business to New York. 

The question next arises how the price or rate of exchange is 
determined. The factors controlling the price or rate of ex- 
change are as numerous and as difficult to trace as the influences 
which affect the price of any economic good of world-wide 
purchase and sale. However, to facilitate discussion, we may 
classify them as : (i) the amount of pure gold in the monetary 



348 OUTLINES OF ECONOMICS 

units which are to be exchanged, (2) the cost of shipping gold, 
and (3) " general credit conditions." 

An English pound sterling contains as much fine gold as 4.866 
American dollars, and when exactly this amount must be paid in 
New York for a draft or order for one pound payable in London, 
exchange is said to be at par. Sterling exchange and German 
exchange are usually quoted in dollars and cents, i.e. the amount 
of American money required to buy one pound or four marks 
respectively. Consequently, they rise or become dear when 
exchange mounts above par. French exchange, on the contrary, 
is usually quoted in francs, the number of francs purchasable 
with one dollar ; and it is consequently cheap when above par 
and dear when below par. Exchange between the United States 
and countries with silver or paper standards lacks the steadying 
influence of a par determined by the actual mass of fine gold in 
the respective units of value, and hence fluctuates much more 
than exchange between countries on a gold basis. In order to 
be as brief and clear as possible, the following discussion will 
be confined to exchange between countries on a gold basis. 

Fluctuations in the rate of exchange depend chiefly upon the 
" general credit conditions " mentioned above, but it is plain 
that upper and lower limits to these variations are established 
by the actual cost of shipping gold. Suppose, for a moment, 
that it costs two cents to transport $4,866 worth of gold bullion 
between New York and London. Except under unusual cir- 
cumstances, then, sterling exchange could not rise above $4,886, 
nor fall below $4,846. Such limits are frequently spoken of 
as the " gold points," " specie points," " shipping points," or 
" export and import points "; and it is necessary to mention 
them because of their frequent employment in discussions of 
foreign exchange. But they are usually defined in much too 
definite terms. The cost of shipping gold varies with the size 
of the shipment, with freight, insurance, and interest rates, 
and in some degree with the steamer and the season of the year. 
Furthermore, gold is so important as the basis of bank credit in 
all parts of the world that it is frequently imported regardless 
of the rate of exchange. During the war between Russia and 



INTERNATIONAL TRADE 349 

Japan, for instance, the Bank of France imported large quanti- 
ties of American gold in this semiarbitrary way in order to pro- 
tect reserves. The " gold points," then, while in one sense very 
real, represent extreme limits and are in themselves variable. 

Within these extreme limits set by the cost of shipping gold, 
the rate of exchange varies according to general credit condi- 
tions, i.e. with the supply of and demand for bills of exchange, 
with discount rates here and abroad, and the innumerable forces 
which influence discount rates. Suppose, for instance, that our 
imports of merchandise in a given season greatly exceed our ex- 
ports of merchandise. The demand for bills on London would 
greatly exceed the supply of bills on London, and the price 
of sterling exchange would rise very high if no other factors were 
involved. But it may happen at the same time that interest 
rates in New York are higher than in London, and under these 
circumstances our foreign creditors may prefer to lend their 
balances in New York in order to earn the high rate of interest 
obtaining there. The placing of these loans in New York will 
in turn reduce the demand for foreign exchange, and thus moder- 
ate both the interest rate and the rate of exchange. 

After the beginning of the European War, conditions became 
exactly the reverse of those assumed in the preceding illustra- 
tion. Europe bought enormous quantities of goods in this 
country, there was an unprecedented excess of exports over 
imports and a corresponding drop in the rate of exchange. We 
loaned large sums to Europe, extending credits to foreign pur- 
chasers and buying government securities. We also bought 
back a very considerable quantity of American securities. All 
this is indicative of the dependence of international trade upon 
international credit and banking, of the fact that if we sell to 
foreigners we must buy from them or give them credit, of the 
interdependence of foreign exchange, interest rates, and the 
territorial distribution or placing of credit. But it is more in- 
dicative, perhaps, of the facts that the stock of gold is a world 
stock, that the credits resting upon it tend to flow to the point 
where they command the highest price, that the foreign ex- 
changes evince normally a strong aversion to the actual move- 



350 OUTLINES OF ECONOMICS 

ment of gold, and that trade balances are for the most part 
settled by the shifting of credits and securities. 

This interaction of the domestic and the international money 
markets gives rise to a number of complex transactions which 
can only be suggested here. In discussing, on page 347, the 
sale of foreign exchange, American bankers were described 
as drawing against credit balances which they had built up 
abroad. Some bankers' bills, however, the so-called " finance 
bills," are drawn in excess of the foreign balances, and thus repre- 
sent borrowings abroad. Finance bills are used (i) to tide 
over the time before a plentiful supply of documentary bills is 
available; and (2) to take advantage of low discount rates 
abroad, e.g. in London, by borrowing in London and lending the 
proceeds in New York. Under the latter circumstances, finance 
bills payable in London at sixty or ninety days are sold in large 
quantities in New York, the sellers commonly covering their 
risk by the purchase of future drafts calling for the payment 
of the same amounts in London at the dates when the bills 
mature. The finance bill is thus one of many credit instruments 
used to bring the loanable funds of the world to the market where 
they will command the highest rate of interest ; and it is hardly 
necessary to add that it assumes at times a highly speculative 
character. " Bankers sometimes purchase outright entire new 
issues of securities from corporations with proceeds obtained by 
the issue of finance bills, sell the securities to investors during 
the currency of the finance bills, and apply the proceeds realized 
through the sale of the securities to the payment of the bills at 
maturity." ^ 

Regulation of the Gold Supply. — As explained above, com- 
paratively little gold is used directly in international trade. 
Yet there is nearly always some movement of gold. In the 
regular course of her foreign trade, London is constantly shipping 
and receiving gold, and the same is true in a general way of this 
country. In January, 1914, for instance, $10,442,373 in gold 
was imported, while the exports of gold in the same month 
amounted to $6,914,056. 

1 A. W. Margraff, International Exchange, p. 41. 



INTERNATIONAL TRADE 35 1 

In normal times, the discount rate is frequently used to regu- 
late the distribution of gold, particularly in countries having 
central banks. International banking houses keep funds in 
both the United States and Europe, and they are constantly 
shifting their money to the market in which it will earn the high- 
est rate of interest. The means employed to move their funds 
may vary, as has been explained, all the way from the simple 
sale of foreign exchange to the actual importation of gold. So 
great is the influence exercised by the discount rate over the 
gold supply that the Bank of England, as we have seen, usually 
finds it necessary to do nothing more than raise its discount 
rate when it desires to attract gold to England or discourage its 
exportation. But it is important here not to confuse the causal 
relationship. The discount rate does not control the flow of 
gold any more truly than the flow of gold controls the discount 
rate. The two are mutually dependent, and both in turn are 
subject to other independent influences. 

The ordinary price level, that is, of merchandise, similarly 
affects the rate of exchange and the movement of gold. When 
prices abroad are high compared with American prices, foreign 
countries increase their purchases, the supply of American 
bills increases, sterling exchange falls, and if it goes low enough, 
may cause the shipment of gold to this country. Such a condi- 
tion of affairs, for instance, is likely to occur in the autumn 
months, when large exportations of American cotton, wheat, 
and agricultural products create a plethora of bills on London, 
and other things being equal, depress the price of sterling ex- 
change. 

There can be no doubt, then, that the price level does influence 
the movement of gold. It seems equally clear that the gold 
movement influences prices. Some opponents of the 'J quantity 
theory " of prices hold that it does not, maintaining that before 
a drain of gold, for instance, could raise prices, it would so ele- 
vate the discount rate that the drain would be checked. In their 
view, the discount rate acts as a safety valve, through whose 
variations any protracted gold movement which threatens to 
disturb the price level is checked and reversed before it acquires 



352 OUTLINES OF ECONOMICS 

the momentum requisite to accomplish the larger task. But 
this assertion is for present purposes irrelevant. It makes little 
difference whether the supply of gold acts through the discount 
rate or directly. It acts. And we may be sure at least that if 
the movement of gold continued indefinitely, prices would un- 
questionably be affected. Nor should it be forgotten that a 
low discount rate itself affects the price level. In any event no 
country need fear the exhaustion of its specie. A protracted 
excess of imports over exports commonly arouses apprehen- 
sions on the point. Such fears are groundless. A continued 
outflow of gold raises discount rates, tends to reduce prices, 
and so draws back the specie through either new loans or 
new purchases or both. 

The gold supply thus adjusts itself automatically to the respec- 
tive demands of the various districts of the world. This truth 
is important because it establishes a prima facie presumption 
against laws or policies which interfere with the normal distri- 
bution of the precious metals. This presumption is only an 
initial one, however. It does not follow that " artificial " inter- 
ference with the distribution of the gold supply is never war- 
ranted. Gold is purchasing power, representing universal and 
instantaneous command over men and things, and as the foun- 
dation of bank credit it is not too much to say that upon it 
modern industrial civilization rests. The governments of to-day 
are dependent in many ways upon the banks, and for this 
reason the movement of gold must continue to be as responsive 
to national political demands as to interest rates and prices. 
Gold may be obtained not only in the course of international 
trade, as that term is ordinarily understood, but by liquidating 
international debts. From the period just preceding the Balkan 
War until the outbreak of the European conflict, Europe steadily 
liquidated or sold back its American securities, inspired either 
by a general feeling of political insecurity or by definite prevision 
of approaching hostilities. Gold moved in this case in obedience 
to forces at once political and commercial ; the regulation was 
both " natural " and " artificial." 

In times of war, panic, or severe financial stringency, extraor- 



INTERNATIONAL TRADE 353 

dinary expedients for obtaining gold are sometimes used which, 
like the heroic remedies employed in desperate illness, are necessi- 
tated by the exigencies of the situation. In the scramble for 
gold which precedes a war or attends a panic, the country or the 
individual who stands aloof and waits for the normal laws of 
distribution to bring him " his " share of the gold supply may 
have cause to regret his inaction. Nevertheless, it is true that 
such expedients, like strong drugs, are to be used with great 
caution. They are frequently employed when the situation 
does not demand them, their use tends to become a fixed habit, 
and they seldom accomplish more than the postponement of the 
crisis. An expedient of the kind described was employed by 
Mr. Shaw, then Secretary of the Treasury, in the spring of 1906. 
The following critical account of the action of the Secretary may 
be unjust to him, for it must be remembered that the financial 
stringency of the time threatened to become dangerous ; but it 
illustrates in a striking way the subtle modern devices sometimes 
used to increase the supply of gold. 

"On April 14 it was officially announced for the first time, that the Sec- 
retary would allow any depositary bank which engaged to import gold to 
anticipate the arrival of the gold by withdrawing a Hke amount in cash from 
the Treasury upon pledge of savings-bank collateral as security. The sum so 
withdrawn was to be regarded as a temporary loan, and to be returned to the 
Treasury as soon as the gold arrived. In providing such an arrangement, Mr. 
Shaw virtually reduced the cost of importing gold by the amount of interest 
during transit, and raised by so much the 'gold import point.' In other 
words, he endeavored to make it profitable for the depositary bank to 
import gold without waiting for sterling exchange to fall to the normal 
'gold point.' ... In accomplishing this, Mr. Shaw temporarily elimi- 
nated, so far as the national banks were concerned, one item of expense in 
their foreign exchange operations. He gave them an advantage, for the 
time being, over all other firms engaged in the same business; and his 
action naturally excited criticism among the private bankers who found 
themselves discriminated against. Critics also attacked his method of 
announcing his decision. It appeared that several days before the public 
or the other banks were informed of his intention, Mr. Shaw had seen fit 
to make private arrangements with two New York banks for gold imports 
under the plan . . . Nor was hostile criticism mitigated by the general 
publication at this moment of the fact, which had not been widely known 
before, that one of these same banks had been favored by the Treasury for 

2A 



354 OUTLINES OF ECONOMICS 

several weeks, and possibly months, preceding, with virtually the same 
privilege under a different guise. This had been accomplished by allowing 
the bank in question to count as part of its reserve its importations of gold 
during their period of transit to New York. The imported gold had thus 
been made practically available as a basis for loans from the moment of its 
purchase abroad, and the item of time cost in such imports had been as 
completely eliminated as under the subsequently adopted plan. . . . His 
[Secretary Shaw's] statement issued at the time seemed to indicate that, 
in his opinion, the natural movement of gold was toward this country, but 
that the flow was being lured to other markets by the practices of European 
banks. He apparently hoped to overcome what he took to be an artificial 
diversion of gold from the United States by adopting, through the agency 
of the Treasury, measures similar to those which were being employed by 
the French and German central banks." i 

It is this fear of panic and fear of war that to a large degree 
explain the actual shipment of gold, with its risk, expense, and 
loss by abrasion. If we could be assured of permanent peace 
and had a perfect credit system most of the gold movement 
would be unnecessary. If London were entitled to a gold 
balance from New York, a negotiable instrument evidencing 
that debt would under most circumstances suihce ; or the gold 
could actually be set aside in the vaults of the New York sub- 
treasury, marked with a London label and held until an opposite 
state of exchanges made it necessary to change the labels. 

The Balance of Trade. — Although credit devices make it 
unnecessary to settle current trade balances with gold, the notion 
still persists that an excess of merchandise exports is a good 
thing and an excess of merchandise imports a bad thing. We 
still speak of the former as a '' favorable " and of the latter as an 
" adverse " balance. To sell abroad as much, and to buy 
abroad as little as possible still seems the ideal of many well- 
meaning legislators and intelligent journalists. 

Suppose for the purposes of discussion that the United States 
succeeded in prohibiting imports for a long period, while at the 
same time it succeeded in selling a large amount of merchandise 
to foreign purchasers. What would happen? Evidently a 
large portion of the money of the world would accumulate in 

1 A. P. Andrew, Quarterly Journal of Economics, Vol. xxi, pp. 544-546. 



INTERNATIONAL TRADE 355 

the vaults of American bankers, interest rates would fall, — 
possibly to rise again later, — and eventually, if the process 
continued long enough, the prices of American commodities 
would ascend to such a level that foreign nations would be un- 
able to continue buying in this country. At this point, evidently, 
our hypothesis breaks down, and we are forced to conclude that 
the original supposition was an impossible one. 

This hypothetical case and its reductio ad ahsurdum are suffi- 
cient to establish certain important pratical conclusions. The 
first is that a country cannot permanently sell goods for money 
alone. If it produces large quantities of the money metals, it 
will regularly sell those metals for the goods and services of other 
nations. If it produces no gold or silver itself, it will secure them 
through exchange ; although, even in this case, gold and silver 
are likely to constitute only a minor part of its imports. Perhaps 
the gravest error one can commit in studying an international 
trade balance is to treat it as an exchange of goods for money. 
It is not even an exchange of goods for goods. The true inter- 
national balance is one of claims against obligations, of credits 
against debits. The complete statement is that the goods, 
moneys, and services rendered by one country to other countries, 
plus its claims and credits of all kinds, will be balanced by the 
goods, moneys, and services received by the same country plus 
its debts and obligations of all kinds. Or, to put the matter 
concretely, we must include, along with the exports and imports 
of merchandise and bullion, the invisible exchanges, loans which 
the country makes or receives, annual interest payments on 
loans and capital invested abroad, repayment of loans or the 
purchase of securities, earnings of ships, insurance premiums, 
and commissions of all kinds for international services, govern- 
mental expenditures in foreign countries for diplomatic service, 
payment of subsidies and war indemnities, remittances of im- 
migrants, expenditures of travelers, and a thousand and one 
other items, all tending, according as they depress or raise the 
price of foreign exchange, to bring about the importation or ex- 
portation of gold for the occasional balancing of the account. 

A mere glance at this list of items entering into foreign trade is 



356 OUTLINES OF ECONOMICS 

suf&cient to puncture the old mercantilist idea that a " favor- 
able balance of trade " or an excess of merchandise exports 
brings about an increase of the money supply. This idea is as 
fully refuted by commercial statistics as by economic analysis. 
In the thirty- three years, 1 874-1 906, for instance, we had a large 
excess of merchandise exports in all except four years, but there 
was an excess of gold imports in only sixteen years. So, similarly, 
there was probably little truth in the statement heard so fre- 
quently when the previous edition of this work was published 
(1908), that our then " favorable balance " indicated that the 
United States was settling its indebtedness to foreign capitalists, 
repurchasing American securities owned abroad, and thus bring- 
ing the control of American enterprises more completely into 
the hands of Americans. It may have meant this, to be sure, 
but it more probably meant that we were paying England in 
goods for carrying and insuring our exports, or that foreign 
owners of American securities were taking in this form the annual 
interest or profits due to them. That excess of exports repre- 
sented the continuance of indebtedness rather than its liquida- 
tion. 

For the same reasons an " unfavorable balance of trade " or 
an excess of merchandise imports is open to a variety of different 
interpretations. It may mean that foreign capital is investing 
more heavily in the country under discussion, or that the latter 
country is taking, in the form of consumable commodities, 
interest and profits on investments which it has previously made 
abroad, or that it is selling its holdings in foreign enterprises 
and taking the proceeds in the form of consumable goods. An 
" unfavorable balance " of trade may thus be, in reality, highly 
encouraging; and a " favorable balance " indicative of national 
waste and extravagance. The precise meaning of any partic- 
ular balance can be determined only after the most careful 
study, and no dependence should be placed upon the offhand 
interpretations of casual investigators. The great truth is that 
there must be some sort of balance between the credits and 
liabilities of any country, and that in practice a nation must be 
willing to buy if it is anxious to sell. 



INTERNATIONAL TRADE 357 

A scholarly analysis of the foreign trade of the United States, with a careful 
interpretation of the meaning of the trade balance at various periods, may 
be found in the North American Review for July, 1901, from the pen of 
Professor C. J. Bullock. Professor Bullock's explanation of the balance in 
two or three periods may be given, in order to illustrate the variety of factors 
which must be taken into account when dealing with this subject. In the 
period 1 789-1820 the imports of merchandise and specie exceeded the cor- 
responding exports by $511,000,000, and our obhgations were further in- 
creased by interest on foreign capital invested in the United States to the 
amount of $200,000,000 approximately. This total indebtedness of some- 
thing over $700,000,000 was offset by the earnings of the American mer- 
chant marine, estimated at about $800,000,000 for the period in question. 
"So far, then, from the country being drained of its money in payment for 
the balance of imported merchandise, the banks held not less than $20,000,- 
000 of specie in the year 1820; while Gallatin and Crawford estimated that 
there had never been more hard cash in circulation." 

In the decade 1831-1840, owing to the high prices current in this country, 
imports exceeded exports by $159,700,000; the imports of specie also ex- 
ceeded the exports by $50,650,000 ; and the earnings of our merchant marine, 
$90,000,000, sufficed only to reduce this "unfavorable balance" to about 
$120,000,000. This remaining balance is accounted for by new foreign 
investments in the United States, in particular by foreign purchases of state 
bonds. "Our large imports of merchandise and specie had been made 
necessary by the movement of foreign capital toward the United States." 

In the decade 1851-1860 the merchandise imports again exceeded the 
exports by $355,800,000 ; the net amount due to foreign creditors was some- 
where between $100,000,000 and $130,000,000; and to offset these adverse 
balances our merchant marine earned in this period only $158,000,000. The 
remaining balance in this case was covered by our large excess of specie 
exports, which amounted to $417,608,000, and was due to the discovery of 
gold in California. "The United States had become one of the leading gold- 
producing regions, and the course of the exchanges was inevitably altered." 

In the periods briefly described above, the striking factors in our inter- 
national trade were, respectively, the earnings of our merchant marine, new 
investments of foreign capital in the United States, and large specie exports 
following the discovery of gold in Cahfornia. In the last period, from 1874 
to 1896, our exports both of merchandise and specie greatly exceeded our 
imports. "This meant simply," concludes Professor Bullock, "that the 
country had assumed its normal position as a debtor nation on the various 
items of invisible exchanges, and was paying annually something like $122,- 
500,000 on such accounts." 

The movement just preceding the European War was marked by features 
of unusual interest. From 1910 to 1914 this country had a normal excess 
of exports. In April, 1914, however, an "adverse" balance showed itself, 



358 OUTLINES OF ECONOMICS 

and in the same month gold began to flow to Europe ; the $50,000,000 
mark was reached in the middle of June and by the end of November the 
excess of gold exports amounted to $175,000,000. In the beginning the 
outflow of gold was attributed to the Underwood tarifl", which stimulated 
imports by reducing duties. But gold continued to flow for a considerable 
time after the excess of merchandise imports had given way to an unprec- 
edented excess of exports. As a matter of fact the continued exodus of 
gold was due far more to a wild scramble for gold abroad, particularly on 
the part of Russia; to the forced "importation" of American securities 
from Europe; and to large European loans placed in this country than to 
the excess of merchandise imports in the spring of 1914. The movement 
of American securities, it may be noted, began long before the declaration 
of war and may possibly have marked the initial preparations for that 
conflict. 

Despite the continuance of heavy European borrowings, our decreased 
importations from Europe and our heavy exports, especially of munitions, 
turned the tide in December. The excess of gold imports over gold exports 
grew month by month, being nearly $80,000,000 in October alone. For 
the year 1915 the excess of gold imports amounted to $420,500,000. 

Restriction of International Trade. — In ancient times among 
many nations, such as the Hebrews and Chinese, contact with 
other peoples was feared and foreign trade was practically pro- 
hibitedi In Greece and Rome the greatest thinkers entertained 
a profound contempt for trade, based in part upon the belief 
that in exchange one party is usually cheated ; and this prejudice 
was partially justified by the character of the primitive trader, 
who was part sailor, part pirate, part merchant, and took all 
the profit he could possibly extort in every transaction as in- 
surance against the great risks of his calling. 

At a later date, in the Middle Ages, when commerce between 
the semi-independent cities of western Europe increased, trade 
came to be highly prized by the average citizen, although it was 
still condemned by the philosophic schoolmen; and it was 
regulated in the most exclusive spirit. 

"Every effort was made to keep trade as much as possible in the hands 
of native citizens. For example, the Venetians forbade the Germans from 
engaging in trade with the East by way of Venice, and the citizens of Lubeck 
strove to keep the Baltic trade from the Dutch. . . . Foreigners were 
mistrusted and partnerships with them were forbidden. Foreign visitors 
were restricted in many ways in their commercial dealings with native citi- 



INTERNATIONAL TRADE 359 

zens. Many occupations were closed to them; the length of their sojourn 
and the number of their visits were limited ; they could not pass a town with- 
out exposing their wares for sale and paying the required mariiet dues. The 
wants of the consumer took precedence over those of the producer or mer- 
chant. At the weekly markets consumers could supply their needs before 
the baker or merchant was allowed to make purchases. There was a com- 
munity interest in the supplies of necessities, and often their exportation 
was prohibited. The trade of neighboring peasants was restricted to the 
home city, and laws regulating price, weight, measure, and quality were 
common. This restrictive municipal policy was very much relaxed at the 
great fairs which were held periodically in various parts of Europe." ^ 

In the early modern period Mercantilism became dominant. 
Commercial policies were controlled by the desire to get and keep 
the precious metals. At first the exportation of specie was pro- 
hibited ; merchants trading abroad were compelled to bring 
home cash for the goods they had taken out with them ; foreign 
merchants trading within the home country were compelled to 
exchange their cash for domestic goods before they departed; 
exportation — except the exportation of raw materials needed 
in the manufacturing industries — was encouraged ; and impor- 
tation — except in the case of the precious metals and the skilled 
artisans who were encouraged to immigrate — was discouraged 
or prohibited. When it became apparent that the supply of 
money had to be secured through international trading, the 
greatest emphasis came to be laid upon the " favorable balance 
of trade " ; and means, ranging all the way from bounties to 
war, were vigorously employed to secure the carrying trade for 
native ships. 

Much mercantihstic legislation was immoderate, some of 
it barbarous, most of it marked by short-sighted national 
jealousy. Adam Smith has held it up to scorn. Some later 
writers have defended it as in the main necessary. No verdict 
on the subject needs to be given here. It accompanied the weld- 
ing of the great modern states; and the consolidation of the 
smaller autonomies probably removed more restriction and 
more petty mercantilism than the new consolidation called 
into being. 

1 G. M. Fisk, International Commercial Policies, pp. 15, 16. 



360 OUTLINES OF ECONOMICS 

In a large historical sense Mercantilism was merely a cry 
elicited by one of the sharpest of the world's great growing pains. 
It was a symptom more than a cause or an explanation. It 
marked the establishment of the division of labor on a territorial 
basis, and recorded the replacement of the independent economy 
of the Middle Ages by the modern economy of exchange. For 
the latter, money was indispensable, and had to be secured at 
any cost. 

The mercantilist period has been followed — after a brief 
laissez-faire reaction in some countries — by the period of pro- 
tection in which we still linger. The extensive taxation of im- 
ports still continues; but trade prohibitions and export and 
transit duties have been largely abandoned in the more advanced 
countries. In the United States export duties are prohibitedby 
constitutional law. But few nations have wholly risen above 
mercantilist practices. Canada prohibits the importation of 
oleomargarine and similar substitutes for butter ; Great Britain 
prohibits the importation of sugar from countries paying 
bounties on its production ; Switzerland levies an export tax 
on cattle, hides, and skins shipped from the country; Norway 
and Sweden tax the exportation of timber; and Russia still 
attempts to control the Persian trade by levying transit duties 
upon goods passing through her territories destined for Persia. 
But export and transit duties in their old mercantilist uses have 
nearly disappeared. ' . 

Extensive use is still made of export taxes for revenue purposes in South 
America and the Orient; and trade prohibitions based upon grounds of 
sanitation, morals, and what is generally called the "police power," are in- 
creasing rather than decreasing. Turkey, for instance, levies an ad valorem 
tax of I per cent upon all exports; and in general the most important 
tropical products are still subject to export taxes. As for trade prohibitions 
the continued necessity for their occasional employment is illustrated by our 
federal law authorizing the President to suspend the importation of any 
article which he regards as "dangerous to the health or welfare of the people 
of the United States." ^ 

1 For a more complete enumeration of modern export duties and trade prohibi- 
tions, see G. M. Fisk, International Commerical Policies, Chap. vi. 



INTERNATIONAL TRADE 361 

Nature and Advantage of International Trade. — It is obvious 
that there must be some restriction of foreign trade. Fiscal 
necessity, for instance, forces most countries to raise a large 
part of their national revenue by import duties. Until a few 
years ago, " free- trade " England raised more national revenue 
from customs than any other single source of taxation. Trade 
restrictions have existed as long as international trade itself, 
and the real problem is not whether there shall be any restriction 
but where and when particular varieties of restraint are justifi- 
able. To answer that question it is necessary to make some 
examination of the nature and advantage of international trade. 

By far the most important truth in this connection is the 
simple fact that trade is a necessary part of the process of pro- 
duction. Production consists of the creation of utility. The 
production of time and place utility is the primary function of 
trade. Trade, therefore, is as beneficial,, as truly productive, as 
agriculture or manufactures. The American people are just as 
truly engaged in production when they buy pulp from Norway 
as when they cut down their own spruce trees to be manufactured 
into " yellow journals." 

Trade is not only, productive in the sense that it creates 
utilities, but it is an indispensable part of the division of labor. 
Men specialize in the production of those things in which they 
excel. A manufacturer of shoes may be a skilled cabinetmaker 
as well, but except for recreation he will not make his own furni- 
ture. By specializing in shoes he can buy with shoes, or the 
proceeds of their sale, more and better furniture than he could 
make with his own hands. An individual who makes anything 
for himself must figure as part of the cost of production what his 
labor could be sold for in other fields ; and he obviously loses 
money if on this reckoning the thing he makes costs more than 
it could be bought for on the open market. The same is true 
of communities. The city that by grants of land or the remis- 
sion of taxes manufactures within its own borders things that it 
could buy more cheaply outside, loses by the transaction. Not 
only individuals but communities and nations must specialize 
if the maximum productivity is to be secured. There is a 



362 OUTLINES OF ECONOMICS 

territorial as well as a personal division of labor, and trade is 
of the essence of both. 

Exchange remains profitable, even though one of the parties 
is superior in all-around productive efficiency. A good lawyer 
may be able to do better work on the typewriter than his 
typist. But it will still pay the lawyer to specialize in law 
and to buy the stenographic service which he needs. Suppose 
that we were suddenly brought into contact with a country 
over which we had a universal productive advantage. Every- 
thing would be cheaper here ; competition would force the other 
country to buy from us in all lines ; gold would flow from that 
country to this ; prices would fall there and rise here ; in time 
an equilibrium would be reached and the other country would 
sell to us the things in which our productive advantages were 
least important. Articles of export and import would sell at 
the same prices in both countries except for the cost of carriage. 
Wages and the prices of non-transportable commodities might 
differ widely in the two countries, even after the new equilibrium 
had been reached. The question is not how much wages labor 
receives, but what it costs in money to produce transportable 
goods; and these costs may be identical (transport costs in- 
cluded) while wages differ widely, owing to differences in the 
productive efficiency of labor in the two countries. Each 
country manufactures the product in which it has a comparative 
advantage and buys with these products other goods which it 
needs. It specializes in the production of those things in which 
the comparative cost is lowest. This is the law of comparative 
costs. If a group of individuals insist on making something 
which they could buy for less than it costs them to make it — 
counting their labor as cost at what it would bring in other 
lines of industry — there is a comparative loss. 

But what of the non-transportable goods, — houses and the 
like? Assume a state of civilization in which the sole articles 
of consumption and production are flour, cloth, and houses. 
Assume that the United States produces flour and houses, buying 
its cloth from England, and securing by such specialization or 
division of labor more cloth than we could otherwise secure. 



INTERNATIONAL TRADE 363 

Suppose the trade in cloth to be closed and the United States 
forced to manufacture the cloth it needs. Capital and labor 
would be diverted from the production of flour and houses to 
the production of cloth. More houses and more flour would 
have to be paid for a given quantity of cloth. A given quan- 
tity of flour or house accommodation would buy less cloth than 
formerly. In general there would necessarily be less flour, 
cloth, and houses than before ; the general productivity of labor 
and capital would be reduced ; and houses would be affected 
exactly like flour and cloth by the lowering in the general 
level of productivity. Non-exportable goods might be cheap 
or costly ; that would depend upon the productivity of labor 
and capital in each country. But that productivity is directly 
affected by the productivity of labor engaged in the production 
of export goods, and if the productivity of the latter is lowered 
the productivity of the former will also be reduced. 

The fundamentals of the problem are not changed by the 
introduction of money. When the importation of cloth was 
stopped England for a time would continue to buy flour ; but, 
the price of cloth being raised, our purchases would fall off at 
once ; specie would move from England to this country ; prices 
would rise here and fall there ; capital and labor would be at- 
tracted to the production of cloth ; wages as well as prices would 
rise here. This is the initial and obvious effect of trade restric- 
tion. For a time it raises prices and money wages and gives a 
fiflip to trade by making it profitable to start a new industry. 
It is no wonder that protection is so popular. It is an industrial 
stimulant. 

But the sequel is different. The flow of specie from England 
reduces wages and prices there, including the price of flour, and 
in time England will be forced to produce more flour for herself. 
This means a stimulus to the flour industry in England and a 
corresponding decline of the flour industry in this country. 
England's " stimulant " comes later. Trade restrictions tend 
therefore, in the first instance, to raise wages and prices in the 
country imposing them ; but in the long run they produce al- 
ternating periods of depression and activity in both countries. 



364 OUTLINES OF ECONOMICS 

and enable one country to injure another by forcing the latter 
to readjust her industries and even to produce things she would 
prefer to secure by purchase. Tariff tinkering is one of the most 
fertile sources of international friction and unquestionably one 
of the major provocatives to war. 

Up to this point our consideration has been confined to two 
countries in the same stage of development, with no great differ- 
ences in wages and interest. What if one country is newer, less 
exploited, and has a higher level of wages and interest ? 

It will be noted in this case that labor and capital would be 
migrating from one to the other, with or without tariff restric- 
tion. If, however, the country with higher wages imposes 
a tariff on cloth, as assumed above, the migration of capital 
and labor ¥/ould be hastened. The development of the cloth 
industry in the younger country would draw some of the labor 
and capital previously engaged in producing cloth in the older 
country. The subsequent decline of the flour industry in the 
younger country, however, would probably not send capital 
and labor back to the old, because there would be better op- 
portunities in the younger country. We can see no escape from 
the conclusion that trade restrictions of this kind do tend to 
hasten migration to the country where real wages are on the 
higher level. The effect of such migration is curious and inter- 
esting. Many writers hold that it does not permanently in- 
crease the population of the newer country, but merely substi- 
tutes immigrants and their offspring for descendents of the older 
pioneers ; while in the older country population is not reduced 
owing to the infinite expansibility of the labor supply within 
the limits determined by the accustomed standard of living. 
But these phenomena need not be considered here. Whatever 
happens will be due chiefly to the fact that real wages and in- 
come are higher in the one country than in the other. Tariff 
restrictions exercise only a minor influence in this connection. 

What if the older country had a positive tariff policy, with 
import duties on some products, when the new country was dis- 
covered and began to develop a foreign trade? In accordance 
with the reciprocal influence upon the division of labor noted 



INTERNATIONAL TRADE 365 

above, existing trade barriers would unquestionably exercise 
an influence, probably a deleterious influence, upon the dis- 
tribution of capital and labor in the younger country. If the 
older country had heavy import duties on agricultural products, 
the expansion of agriculture in the newer country would be 
retarded and the development of manufactures stimulated. 
There can be no doubt about the power of one country in- 
juriously to affect the division of labor in another. But will it 
pay the younger country to adopt countervailing or retaliatory 
duties ? Can it secure the ideally perfect distribution of labor 
and capital by retaliatory restrictions? 

In theory this is partially possible. Revert to the illustration 
in which under normal conditions the younger country would 
produce flour, the older country cloth, and both countries houses. 
Suppose the older country to place a tariff on flour so that more 
flour and less cloth would be produced there. In all prob- 
ability the older country would be forced to continue the im- 
portation of some of the flour which it consumed. Under this 
hypothesis the younger country could set in motion partially 
corrective forces by placing an export duty on the shipment of 
flour, by giving a bounty on the production of flour, or by 
levying an excise duty on the production of cloth within its 
borders. It is interesting to note in this connection that 
England, in order to counteract the protective influence of the 
import duties which fiscal necessity forces her to use, imposes 
an excise duty of equivalent burden on the same goods produced 
within her border, thus counteracting as far as possible any in- 
fluence which the import duties might otherwise exercise on 
production. 

In practice, however, such corrective measures are nearly 
useless. No country knows what the ideal or normal division 
of labor for her would be. Moreover, export duties and boun- 
ties are costly to administer and liable to abuse. Conceivably, 
of course, trade interference by one country may become so 
unreasonable, so unsettling, so capriciously injurious, that other 
countries may be forced to protect themselves. For instance, 
one country may deliberately adopt the policy — by giving 



366 OUTLINES OF ECONOMICS 

bounties or preferential freight charges and the like — of pre- 
venting the development in another country of an industry in 
which the former is specially interested. Under such circum- 
stances other countries may be justified in protecting an estab- 
lished industry by the necessary retaliatory legislation. 

The general political and social aspects of protection are dis- 
cussed in the next chapter. They furnish, as will be seen, some 
theoretical justification for trade restriction. Surveyed as a 
purely commercial question of dollars and cents, however, the 
profitableness of the unregulated territorial division of labor is 
beyond all question of doubt, in the opinion of the authors; 
and the history of international trade fully confirms the bald 
theory here outlined. That theory has been exposed to the 
most searching practical test to which any economic theory 
could be subjected, and it meets the test successfully. If the 
theory of comparative costs is correct, it follows that so long as 
the comparative costs of producing goods vary among the 
different nations of the world, so long there will be some inter- 
national trade. Furthermore, since it is impossible to conceive 
that the costs of producing all kinds of transportable goods will 
ever be exactly proportional in the several countries of the world, 
it is evident that international trading is bound to continue. 
International trade can be permanently suppressed only by 
raising freight charges to prohibitive level, or by deliberately 
manipulating tariffs so as to suppress every new international 
trade connection as soon as it springs up, or by the complete 
destruction of industry in other parts of the world. According 
to theory, then, international trade is for practical purposes 
irrepressible and the ideal of an exclusive home market is a 
delusion. 

This theory, as stated above, has been subjected to the most 
searching test. During the last fifty years trade restriction has 
been piled on trade restriction and protective tariff walls have 
been built higher and higher. But there has been no diminution 
in international trade. On the contrary, it has increased and 
developed by leaps and bounds. 



INTERNATIONAL TRADE . 367 

QUESTIONS 

1. In what respects does foreign exchange dififer from exchange between 
two American cities? 

2. What are the principal influences which affect the rate of exchange? 

3. Is the gold supply distributed according to the needs or the respective 
demands of the various countries ? Are needs and demands in this connecx 
tion identical ? 

4. Mention as many methods as you can by which governments have 
endeavored to increase the supply of gold. 

5. What is meant by the law of comparative costs? Is the American 
custom of importing the finer textile fabrics and manufacturing the coarser 
ones an effect of this law ? 

6. If a widow needs money so badly that she is willing to pay 200 per 
cent a year for its use, is it wrong for a monej^ lender to charge this rate? 

7. What is the real nature of the balance of trade? Does our excess of 
exports (merchandise) mean that we are paying off our foreign indebtedness, 
or merely that we are paying interest on our foreign indebtedness? 

REFERENCES 

Bastable, C. F. Theory of International Trade. 

Brown, H. G. International Trade and Exchange. 

Clare, George. The ABC of the Foreign Exchanges; The Money Market 

Primer. 
Escher, Franklin. Elements of Foreign Exchange. 
FiSK, G. M. International Commercial Policies. 
GiFFEN, Robert. "The Use of Export and Import Statistics," in Economic 

Inquiries and Studies, Vol. i, Chap. ix. 
GoscHEN, G. J. Theory of the Foreign Exchanges. 
Laughlin, J. L. The Principles of Money, Chap. x. 
Margraff, a. W. International Exchange. 

Mill, J. S. Principles of Political Economy, Book iii, Chs. xvii-xx. 
Spalding, W. F. Foreign Exchange and Foreign Bills. 
Taussig, F. W. Some Aspects of the Tariff Question, Part i. 
Withers, Hartley. Money Chmging. 



CHAPTER XVIII 
PROTECTION AND FREE TRADE 

We are now in a position to review intelligently the pros and 
cons of the modern tariff controversy. Because of the limita- 
tions of space, the discussion will be confined almost wholly 
to American conditions, although most of the arguments are 
applicable to other countries as well. 

The Case for Protection. — i. One of the most captivating ar- 
guments for protection is the assertion that it promotes national- 
ism, which is held to be a good thing. Domestic trade, it is 
claimed, draws the citizens of a country together, while interna- 
tional trade is cosmopolitan and tends to their separation. 
Upon the creation of our federal government, state tariffs 
were abolished and their place taken by a national tariff designed 
partly to protect the whole of the country against the rest of 
the world. The introduction of national protection thus went 
hand in hand with the promotion of internal free trade ; and 
Professor Schmoller even maintains the general thesis that, 
historically, this double process of internal abolition and external 
extension of tariffs marks the formation of new states, partic- 
ularly federal states. Protection against foreign competition, 
he asserts, is thus historically coincident with the enfranchise- 
ment of internal trade.; and has as its main object the creation 
of a strong national economic unity, without which permanent 
political unity, he thinks, is impossible. The validity of this 
argument, it will be noted, depends largely upon the truth of 
the assumption that the development of a strong feeling of 
national unity is a thing to be desired. 

2. Government should, the protectionists say, foster infant 
industries in order to develop our natural resources and to pro- 

. 368 



PROTECTION AND FREE TRADE 369 

duce diversity in industrial pursuits. It is admitted that pro- 
tection is temporarily expensive, but so is the prohibition of 
child labor temporarily expensive. We prevent children from 
earning a little while they are young in order that they may earn 
more when they are old. For the same reasons trade unions 
rightfully insist that apprentices shall be given a broad knowl- 
edge of the trade they are learning, although it is more profit- 
able for the employer to have them specialize early in some 
narrow branch of the work. So, similarly, protection prevents a 
nation from specializing too exclusively in its undeveloped stage, 
in order that it may the sooner arrive at industrial manhood. 

Economists have generally admitted that there is a certain 
amount of truth in this argument. If an industry gets an early 
start in a given district, this locality is likely to retain its advan- 
tage because of the concentration there of capital and labor ac- 
quainted with the requirements and possibilities of the industry. 
Thus 63.3 per cent of all the needles, pens, hooks and eyes, manu- 
factured in this country are made in Connecticut, for no other 
reasons that one can see than those suggested in the explana- 
tory phrase — "the momentum acquired by an early start." 
And this localization of industry is artificially fostered by the 
practice, common to exporters all over the world, of selling 
abroad more cheaply than at home. The export trade seems 
to be universally coddled. Of course, such localized industries 
can be maintained only when the cost of transporting the article 
is small ; and when other districts do not possess unusual 
natural advantages in the way of accessibility to superior raw 
material, power, or skilled labor. The census studies in the lo- 
calization of domestic industries ^ seem to indicate that while 
the industrial inertia of which we have been speaking is an im- 
portant factor, it is not so important as the opposing forces 
making for territorial diffusion of industry. 

A most interesting illustration of an attempt to crush the "infant indus- 
tries" of a competing nation is found in the efJort of English manufacturers 

1 Special Census Report, Manufactures, 1905, Part i, p. cclx. Cf. also, Twelfth 
Census, Manufactures, Part i, pp. cclx-ccxiv; and Thirteenth Census, Vol. viii, 
Chap. vii. 

2B 



370 OUTLINES OF ECONOMICS 

after the War of 1812, to recover the American market of which they had 
been temporarily deprived by the long period of nonintercourse. "English 
manufacturers, eager to regain control of the lost markets, sent in ship- 
loads of cotton and woolens and iron manufactures, which they offered on 
the most liberal terms to their agents in this country. The goods were 
taken on credit and disposed of at auction. The object was to imdersell 
at any cost, and thus break down the infant industries. Lord Brougham 
justified the speculative character of this trade on the ground that 'it was 
well worth while to incur a loss upon the first exportation, in order, by the 
glut, to stifle in the cradle those rising manufactures in the United States 
which the war had forced into existence contrary to the natural course of 
things.'"^ 

3. Closely connected with the preceding arguments is a de- 
fense of protection based upon grounds of war and military 
necessity. Industrial independence, it is asserted, prepares a 
nation better for international war. There is unquestionably a 
great deal of truth in the argument. Germany has deliberately 
used protective tariffs to preserve herself at least in part as an 
Agrarstaat, and there has already been striking evidence of the 
wisdom of her policy of maintaining a large measure of economic 
self-sufficiency. Certainly a wise nation will see to it that within 
its boundaries factories exist which can manufacture arms and 
all the necessary munitions of war. Success in war is not de- 
pendent upon arms and ammunitions alone. There must be a 
plentiful supply of money, and whatever use may be made of 
credit, enormous amounts of money must be raised by taxation.^ 
The source of taxation is a flourishing condition of private in- 
dustry; and the industry of the average nation dependent 
upon international trade cannot flourish in times of war. But 
even the ability to secure public revenues in adequate quantities 
is less important in time of war than the ability of a nation to 
feed and clothe its people and its armies when international trade 
is suddenly cut off. The failure of the South in the Civil War 
was very largely due to her industrial dependence upon the 
cotton export trade. A sufficient diversification of industry to 

1 Coman, Industrial History of the United States, p. i8s- 

^ For a classic explanation of the dependence of both public credit and taxation 
upon a flourishing condition of private business in times of war, see Henry C. Adams, 
Public Debts. 



PROTECTION AND FREE TRADE 37 1 

prevent industrial paralysis and to insure an adequate supply 
of the necessaries of life in times of war is, we believe, mani- 
festly desirable. 

4. The home market argument for protection naturally follows. 
Much that is said in defense of this claim is childish or silly. 
One distinguished American economist seriously maintained 
that a country can remain permanently prosperous only on 
condition that what is taken from the soil shall be returned in 
manure and other kinds of fertilizers, and that this will be ac- 
complished only when the products of the soil are consumed 
at home. A much stronger application of the argument, how- 
ever, is found in the assertion that the home market is superior 
because it is a surer market. A foreign market is usually a pre- 
carious market. It is likely to be closed by war or by capricious 
changes in tariff policy. Protection is unquestionably expen- 
sive to the country that protects, but in the long run it is worth 
paying something to keep industries in continuous operation. 

5. This brings us to the argument for protection as a defense 
against " dumping.'' By dumping is meant the sale of products 
abroad at prices lower than those charged at home. Dumping 
arises in a variety of ways. Export bounties may be granted 
by the home country for the specific purpose of encouraging 
foreign trade ; or a monopoly may find it profitable to dispose of 
a surplus abroad at prices which would be needlessly low in the 
highly protected home country ; or manufactures may avail 
themselves of the difference between fixed and variable expenses 
of production to secure some profits over the specific or variable 
expenses of production by selling abroad at prices which would 
not be remunerative if applied to their entire output. More- 
over, there is good reason to believe that many manufacturers for 
the export trade make it a practice to sell abroad at unusually 
low prices whenever they believe that their foreign market is 
threatened. As was stated above, the custom of " coddling " 
the export trade seems to be very general. 

Now if the reduction of prices were permanent, the country 
in which the products are dumped would have no real cause for 
complaint. On the contrary, it might logically regard itself as 



372 OUTLINES OF ECONOMICS 

the beneficiary of the costly bounties of the other nation. But 
real dumping is not, and in the nature of things cannot be, 
permanent. So far as it may be said to have a rational object, 
it aims to secure foreign markets by selling temporarily at prices 
which in the long run would not be profitable ; and when the 
market is secured, prices will be raised. So true is this that 
economists have generally indorsed import taxes and other tem- 
perate retaliatory measures designed to abolish dumping. 
Canada, for instance, has authorized the levy in such cases of a 
special dumping duty " equal to the difference between the 
selling price of the article for export and the fair market value 
thereof for home consumption." A few years ago the beet- 
sugar industry of France and Germany was so stimulated by 
bounties that even England, the principal dumping ground 
of the product, was forced to threaten reprisals in the shape of 
countervailing import duties. England's resolute attitude, it 
may be added, led finally to the virtual abolition of sugar 
bounties at the International Sugar Conference of 1903. In 
general, there seems to be ample justification for protective 
duties that are honestly used to ward off destructive attacks upon 
home industries which, if subjected only to legitimate competi- 
tion, would be able to maintain themselves in the long run. It 
is evident that we have here returned to the substratum of truth 
contained in the infant industry and home market arguments. 

Dumping has been more productive of arguments against protection than 
of arguments for protection, in the United States ; and the opponents of pro- 
tection have laid great emphasis upon the fact that many articles of Ameri- 
can manufacture are sold abroad more cheaply than at home. That this is 
a fact is now generally admitted. But the protectionists maintain that 
most of this can be explained by the rebates allowed to American exporters 
under our drawback laws. Ex-Secretary of the Treasury Shaw estimates 
that in 1906, owing to these drawbacks, about $140,000,000 of American 
manufactures might have been legitimately sold abroad at less than domestic 
prices.^ 

6. Intimately related to the arguments which we have been 
considering is the claim that the utilization of labor and capital 

1 Leslie M. Shaw, Current Issttes, Chap. xxi. 



PROTECTION AND FREE TRADE 373 

of a free-trade nation is subject to the control, and indeed, one 
may say, to the whim and caprice oi foreign nations. Industries 
differ in their effect upon the physique and character of the 
people who pursue them. The builder, the skilled engineer, the 
electrical worker, are benefited intellectually, physically, and 
morally by their occupations. But the tailor, the maker of 
ready-made clothing, and the sweat-shop worker are probably 
harmed rather than elevated by the nature of their employment. 
Now if foreign nations subsidize by protection and bounty the 
desirable industries, they may leave to the free-trade nation 
only those industries which the protected nations do not wish 
to maintain. 

7. Finally, protectionists appeal to the wage-earning classes 
with the argument that protection increases wages by diversify- 
ing industry and thus stimulating the demand for labor. Indeed 
the typical protectionist goes farther than this, and maintains 
that every American industry is entitled to an amount of pro- 
tection equal to the difference between the wages which it pays 
and the wages paid by its most efficient foreign competitor. The 
latter variety of this argument seems to be plainly absurd, or at 
least obviously inconsistent with the initial assertion that pro- 
tection raises wages. For, taken together — and they are 
frequently advanced in company — they result in this magnifi- 
cently cumulative plea for ever increasing tariffs : protection 
raises wages — but high wages put the American manufacturer 
at a disadvantage in competing with foreign producers — and 
the home producer must be protected to the extent of the differ- 
ence in wages — therefore every advance in protective duties 
laid for the benefit of the wage earner must be accompanied 
by an additional advance for the benefit of the manufacturer — 
and so ad infinitum. 

8. That protective duties should be used to " equalize costs of 
production " here and abroad, has been widely advocated as 
the modern and scientific basis of protection. It would be hard 
to find a more unscientific proposal. In the first place it is 
vague and uncertain. Costs of production are not uniform, 
either here or in foreign countries. What costs are to be 



374 OUTLINES OF ECONOMICS ^ 

equalized ? — costs to the most efScient producer here and the 
most efficient producer abroad, or costs to the " typical " 
producer here and the " typical " producer abroad, or costs to the 
least efficient producer here and the most efficient producer 
abroad? In the second place, certain costs, such as rent and 
even wages, are more or less dependent upon tariff duties them- 
selves, so that the proposal to determine duties by costs merely 
get us into the vicious circle noted above. Furthermore, there 
is no logical or natural limit to this process. If we are to equalize 
costs in the textile and steel industries, why not equalize costs 
in the production of bananas, coffee, and tea? 

As a matter of fact if this program could be carried out it 
would stop all trade and so wipe out the whole gain from the 
international division of labor. But fortunately the program 
cannot be carried out. Economic goods take on a thousand 
forms. We bar the importation of one variety only to find an 
equivalent exchange springing up in another variety. This is 
what we should expect from the theory of international trade, 
and theoretical expectations are amply confirmed by history 
and statistics. 

Arguments of Free Traders. — In the first place, we may dis- 
miss a number of arguments which are so extreme as to weaken 
rather than strengthen the cause of free trade. 

1. For instance, it is frequently alleged that protective 
tariffs violate the assumed natural right of every man to 
buy his goods where he will and sell his products wherever 
he sees fit, untrammeled by human laws. The futility of 
arguments based upon an assumption of natural rights has 
been sufficiently exposed elsewhere, and needs no elaboration 
at this point. 

2. It has also been claimed that protective tariffs in the United 
States are unconstitutional, but this argument is idle ; it would 
be most unfortunate and anomalous if nowhere in our country 
were lodged the power to pass such regulations regarding in- 
ternational commerce as might appear to be required for the 
promotion of the public welfare. Furthermore, the charge of 
unconstitutionality does not correspond to the opinion of our 



PROTECTION AND FREE TRADE 375 

best jurists and there are no decisions of the Supreme Court 
which in any way tend to support this claim. 

3. In a similar vein protectionism has been called socialism, 
but this epithet is so generally applied to whatever a person in- 
competent to argue a cause does not like that it will scarcely 
terrify any one. 

The really able arguments of free traders are those which 
aim to show either that protection actually does positive harm, 
or that it fails to accomplish its ends, or that those ends may be 
better accomplished without protection. 

I. The natural starting point of the free-trade argument, and 
the goal to which it inevitably returns, is the theory of comparative 
costs laid down on page 362, the proposition that, so long as 
there are relative, not necessarily absolute, differences in the cost 
of producing cheaply portable articles in various countries of 
the world, so long will there be international trade in those 
articles. Protective tariffs, therefore, merely divert capital and 
labor from intrinsically more productive to intrinsically less pro- 
ductive industries. To revert to our simile of the lawyer and his 
stenographer, protection aims to induce the lawyer to write his 
own letters, on the general grounds that lawyers are more intelli- 
gent people than stenographers, and if sufficient encouragement 
be held out to them they may, in the course of time, be educated 
up to the point of operating their own typewriting machines 
better than the stenographers whom they have previously hired. 

Temperate advocates of " freer trade " do not contend that 
this law of comparative costs demonstrates the desirability of 
complete free trade under all circumstances. They admit that 
it may occasionally be profitable for a country to pay enormous 
bounties — this is what protection amounts to — for the de- 
velopment of certain industries. But they do contend that it 
establishes free trade as the general rule, every departure from 
which should require the most positive justification. More par- 
ticularly, they hold, that at the present time, after a century of 
industrial development that obviates any military necessity for 
a further diversification of industry, capital and labor should be 
freely allowed to take themselves to those employments in 



376 OUTLINES OF ECONOMICS 

which they can reap the largest natural reward, a reward, that is 
to say, which is not artificially enhanced by subsidies wrung from 
the general body of consumers. 

2. Moreover, it is not clear that protection is necessary to 
diversify industry in a country with such varied natural resources 
as the United States. The claims of the protectionists at this 
point may be tested by examining conditions within the wide 
borders of our own country, within which trade is wholly free. 
Now, if protection were necessary to foster infant industries 
and bring them to maturity, the manufacturing industries of this 
country would still be concentrated in the northern states of 
the Atlantic seaboard where they first gained a foothold. But 
they have not been so confined. The early establishment of the 
textile industries in New England has not prevented their recent 
development in the South. Indeed, the so-called " center of 
manufactures " moved steadily west from south-central Pennsyl- 
vania in 1850 to central Ohio in 1900; and the increase, at the 
present time, is much more rapid in the South and West than 
in the older sections of the country. Internal free trade has not 
prevented the diversification of industry in the United States, 
and has not delayed it longer than was desirable. For who shall 
say that the Dakotas and other typical agricultural states of the 
Union have greatly suffered from the absence of grimy factory 
towns ? 

3. The inevitable spread of manufactures throughout the 
United States suggests the essential weakness of the home 
market argument. International trade expands just as inevitably 
as the manufacturing area. It might be desirable to confine 
domestic producers to the more certain home market, which 
cannot be destroyed by tariff .wars or international complications. 
But, as a matter of fact, home products will seek foreign markets, 
and the nation that sells abroad must buy abroad. Since the 
Civil War we have protected home producers with extremely 
high tariffs. But in the last thirty years our foreign trade has 
increased at a rate unequaled by any of the other great commer- 
cial countries of the world. ^ Protective tariffs can cripple and 

J Special Reports of the Census Office, Mmmfactwes, 1905, Part i, p. ccc. 



PROTECTION AND FREE TRADE 377 

harass and distract foreign trade, but they cannot permanently 
suppress it. No tariff can make the costs of producing all the 
articles common to commerce precisely proportional in all 
quarters of the globe. 

4. The protectionistic appeal to the wage earner seems par- 
ticularly inconclusive. One reason for distrusting it is the 
double-faced way in which it is manipulated to suit the partic- 
ular requirements of time and place. France wants protection 
in order to protect her low-paid workmen against the greater 
skill and efficiency of America's highly paid workers. The 
United States, on the other hand, must have protection in order 
to shield her highly paid employees from competition with the 
" pauper labor of Europe." When first used in the United States 
the argument was that wages were already so high in this country 
as compared with England, that it was impossible for manufac- 
turers in this country to pay the American rates and continue 
to compete with English manufacturers. Later, cause and 
effect, as related in the earlier syllogism, were reversed, and it 
was asserted that the high wages in this country were due to 
protection, from which it followed naturally that in order to 
raise wages higher, still more protection would have to be given. 

We cannot arrive at any useful conclusions concerning wages, 
however, without considering the efhciency of labor and the pro- 
ductivity or favorableness of the environment in which the 
laborer works. The reason why American labor may receive 
higher wages and yet have nothing to fear from the competition 
of less highly paid workmen in Europe is found in the great pro- 
ductivity of American labor (though this greater productivity 
may depend more upon the natural wealth of this country than 
upon any innate technical superiority of the American workmen) , 
The average American workman is in no more danger from the 
goods produced by the " pauper labor" of Europe than the highly 
paid workman of Montana is threatened by the products of his less 
remunerated fellow-workmen of New England and the South. 
Labor competes with labor, not with commodities. Conse- 
quently, if it is really desired to protect labor, the logical way 
would be to place a tax on imported labor, or by other measures 



■378 OUTLINES OF ECONOMICS 

to reduce immigration. If this were done, those who desire labor 
would be obliged to pay heavily for it, as actually happened in 
England after the " Black Death " in the fourteenth century had 
killed off a large part of the laboring population. Indeed, if our 
tariff makers are sincerely anxious to benefit labor, they should, 
after rendering labor scarce and dear by restricting immigration, 
encourage the importation of such commodities as are consumed 
primarily by wage earners, in order that labor may secure an 
abundance of them cheaply. 

No intelligent free trader would deny that there are now dependent upon 
protection many industries which pay high wages, nor that the sudden aboli- 
tion of protection would throw many wage earners out of work. Their con- 
tention in the first case is merely that by taxation and by diverting capital 
and labor into naturally unproductive industries, protection lowers the. gen- 
eral level of real wages. Their reply to the second point is that protection 
affects the industrial organism much as the alcoholic habit affects the human 
organism. To abandon the habit suddenly would certainly be painful and 
probably dangerous — but this is sufficient reason neither for increasing 
the dram nor delaying the gradual abandonment of the habit. 

5. Turning to the fiscal aspects of the question, the free trader 
asserts that there is little or nothing to be said in favor of protec- 
tion. The protective import duty, as compared with the import 
duty " for revenue only," is a poor tax. It is uncertain and 
viciously variable, and in the great majority of cases is borne 
by the home consumer. To the extent that it does not prevent 
importation it affords no protection; and in so far as it does 
protect, it yields no revenue to the government. If it raises the 
price of the article upon which it is levied, however, the increase 
constitutes a tax upon one class of society — the consumer — ■ 
for the benefit of another class — the producers of the article. 
One authority, perhaps the foremost authority, upon the Ameri- 
can tariff problem, estimates that the tariff upon sugar imposed 
by the Payne- Aldrich Act of 1909 resulted in an annual tax 
upon American consumers of $101,000,000, of which $52,400,000 
went into the treasury and $48,600,000 into the hands of sugar 
producers principally resident in Hawaii, Porto Rico, and Cuba.'- 

1 Professor F. W. Taussig, in the Atlantic Monthly, March, 1908, p. 342. 



PROTECTION AND FREE TRADE 379 

In answer to this charge that protection involves the taxa- 
tion of one class for the benefit of another class, it is not sufiicient 
to reply that everybody is free to take advantage of the subsidy 
and engage in a protected industry. Everybody is not free to 
establish a rolling mill or a silk factory or a tin-plate plant. 
Protection means the taxation of the less acute, the less enter- 
prising, the less educated, and the poorer classes in order to 
create additional commercial opportunities for the abler, 
wealthier, and better-educated classes, thus reversing the whole 
spirit of modern taxation which contemplates — so far as it 
may be done without danger — rather the taxation of the rich 
for the assistance of the poor than the taxation of the poor for 
the benefit of the rich. It is not implied, of course, that pro- 
tection involves class legislation of an unlawful character, nor 
that taxes are collected from one class and handed over in cold 
cash to the members of another class. The point turns upon 
the relative ability of the various social classes to take advantage 
of artificial opportunities created by the state at enormous 
expense to all. 

6. This brings us naturally to the ethical criticism of protec- 
tion, the charge that by making the temporary prosperity of 
influential classes dependent upon government bounty, protec- 
tion encourages those classes to exert a demoralizing pressure 
upon federal legislation. So great is the stake of private in- 
terests in tariff legislation, that systematic lobbying, log rolling, 
and corruption of the voter follow as inevitable consequences. 
The beneficiary of the tariff sacrifices his disinterested convic- 
tions concerning the general welfare, in order to preserve his own 
little subsidy from the government. Neither the citizen nor 
the legislator can vote purely, when his pocketbook is so vitally 
affected. Even if we admit what is probably true, that protec- 
tion has resulted in comparatively little direct bribery of legis- 
lators, there seems no escape from the conclusion that it creates 
a kind of interest in legislation which is inherently dangerous 
and exceedingly difficult to keep within legitimate bounds. 
The weightier arguments for protection all imply that tariff laws 
should be scientifically adapted to secure the real national 



380 OUTLINES OF ECONOMICS 

purposes of protection. The impossibility of getting a " scien- 
tific tariff " under the political conditions that protection 
creates is possibly one of the strongest arguments against pro- 
tection. 

7. Finally, it is alleged that protection fosters monopoly. 
This contention forms the subject matter of a particularly 
heated dispute, the exact truth of which is difficult to determine. 
Certain modifications of the more extreme charge, however, are 
hardly open to question. Protectionists confessedly take it for 
granted that if foreign competition is shut off or lessened, home 
producers will still compete. Nevertheless, highly protective 
duties are still levied, or until the passage of the Underwood 
tariff were levied, upon the import of commodities whose manu- 
facture in the United States had fallen under the substantial 
control of monopolies. It is furthermore admitted that such 
monopolies frequently sell their products at lower prices in 
foreign countries than in the United States ; while it is impossible 
to deny that — whether the monopoly was created by protection 
or not — the abolition of the duties, by giving foreign producers 
a chance to compete in this country, would tend to reduce prices, 
and thus give the American public a valuable ally in their 
struggle against monopoly. It is not asserted that the tariff 
has been " the mother of the trusts." Other and more impor- 
tant forces are mainly responsible for the development of the 
trust. But protective tariffs have unquestionably deprived 
the American people of a strong weapon against the trusts. 

Some General Considerations. — Before attempting to sum 
up the preceding arguments and strike a practical working bal- 
ance, it is necessary to call attention to certain general considera- 
tions which have not figured in the foregoing " starched proces- 
sion " of pros and cons. In the first place, it is necessary to 
remember that the federal government must secure a large rev- 
enue from tariff duties, and that in consequence the question 
which we are discussing is not one of protection versus free trade, 
but of protection versus freer trade. In the second place, 
the economic importance of the whole controversy has unques- 
tionably been exaggerated. We find a country like England 



PROTECTION AND FREE TRADE 381 

prosperous under free trade ; we find countries like France and 
the United States prosperous under protection. It is of real 
but not of vital importance. Our internal trade vastly exceeds 
our foreign trade in every way. The domestic trade of the 
Mississippi Valley alone is far greater than our entire foreign 
commerce. In the third place, the American tariff is a historical 
growth, and, bad as it may be in many respects, it has taken 
deep root. During the last century it has become part of our 
life, and cannot be suddenly eradicated with impunity. If it 
is true that American labor would be better off without it, it 
does not follow that it ought to be removed suddenly in the 
interests of American labor. If the industrial growth is ab- 
normal, it is none the less true that adjustment to normal 
conditions is a painful process and should be conducted cau- 
tiously. Displacements of labor and capital cause suffering 
and loss, and it is clear that any reform of the tariff must be 
conservative and careful, a movement toward freer trade, not 
the sudden withdrawal of protection. 

Conclusions. — Most of the arguments enumerated above, 
both for and against protection, contain a measure of truth. 
Historically, protection was inevitable in the United States, 
and, in the early period of the country's development, beneficial. 
During the three great wars which seriously threatened the 
stability of this country, many new industries sprang up which, 
upon the cessation of war and the resumption of internal trade, 
were seriously threatened by foreign competition. Many of 
these industries were so suited to our soil and our people that 
only a short period of protection was needed to make them self- 
supporting. Under the circumstances it would have been unwise 
to permit the sacrifice of the capital invested in these industries ; 
and whether it would have been unwise or not, human nature is 
such that the desired protection was sure to be granted. In 
short, there is a large measure of real truth in the infant industry 
argument. 

Circumstances, however, have radically changed in the last 
few decades. Our quondam infant industries have, for the most 
part, attained a very vigorous maturity, and in some instances 



382 OUTLINES OF ECONOMICS 

have become belligerent and prone to monopolistic bullying; 
our manufactures have become sufficiently diversified to remove 
all danger of industrial collapse in time of war; and, above all, 
we are rapidly entering the economic stage in which, according 
to the ablest exponent of protection that economic science has 
ever known, — Friedrich List, — protection is a hindrance 
rather than a help. That is to say, we are rapidly building up 
an extensive export trade in manufactured articles; year by 
year raw materials constitute a larger proportion of our imports 
and a smaller proportion of our exports ; and we have already 
become the greatest exporting country of the world. All this 
means that in the near future our manufacturers themselves 
will look with kindlier eyes upon the withdrawal of the protec- 
tion they do not need, which in fact actually increases the cost 
of some of their raw materials, and incites foreign governments 
to retaliatory taxation upon goods imported from the United 
States. Our growing export trade will itself bring a wider ap- 
preciation of those fundamental principles which have led 
economists, with but few exceptions, to condemn protection as 
a permanent policy applicable to all stages of economic develop- 
ment. 



QUESTIONS 

1. Distinguish what you believe to be the sound from what you believe 
to be the fallacious reasons for protection, briefly stating your reasons. 

2. Why is a home market believed to be superior to a foreign market? 
Does this apply in all cases? 

3. Explain the argument against dumping. Is dumping more or less 
prevalent than it used to be? 

4. Explain how one country may influence the selection of industries 
in another country. Is this argument sound? What are the limits of its 
truth ? 

5. Can a protective tariff increase money wages? real wages? Ex- 
plain. 

6. State the reasons for, as well as those against, the proposal to use 
tariff duties for the purpose of equalizing costs of production here and 
abroad. 

7. Distinguish what you believe to be the sound, from what you believe 
to be the fallacious, arguments for free trade, briefly stating reasons. 



PROTECTION AND FREE TRADE 383 

8. What is the difference between a " tariff for revenue" and a protective 
.tariflf? Do protective duties make good taxes? Explain. 

9. What effect has protection on legislation? What machinery is pro- 
posed to remedy this evil? 

10. Explain the connection, if any, between high tariffs and monopoly. 

REFERENCES 

Ashley, Percy, Modern Tariff History, 2d ed. (Germany, United States, 

and France). 
Ashley, W. J. The Tariff Problem. * 

Chomley, C. H. Protection in Canada and Australasia. 
Dawson, W. H. Protection in Germany. 
FiSK, G. M. International Commercial Policies. 
FucHS, C. J. The Trade Policy of Great Britain and her Colonies. 
George, Henry. Protection or Free Trade. 
HiGGiNSON, J. L. Tariffs at Work. 
Laughlin, J. L., and Willis, H. P. Reciprocity. 
List, Friedrich. National System of Political Economy. 
Meredith, H. O. Protection in France. 
Patten, S. N. The Economic Basis of Protection. 
Rabbeno, Ugo. The American Commercial Policy. 
Smith, Adam. The Wealth of Nations, Book iv, Chap. ii. 
Stanwood, Edward. American Tariff Controversies in the Nineteenth 

Century. 
Taussig, F. W. Tariff History of the United States, 6th ed. ; Some Aspects 

of the Tariff Question; (editor) State Papers and Speeches on the Tariff. 



PART III 
DISTRIBUTION 

CHAPTER XIX 
DISTRIBUTION AS AN ECONOMIC PROBLEM 

It has already been remarked that the production and the dis- 
tribution of the annual income of society cannot be sharply sepa- 
rated, and more or less has already been said about the four parts 
into which the total social income is usually divided ; namely, 
wages, interest, rent, and profits. The greater part of distribu- 
tion might undoubtedly be considered under the general heading . 
" Production," but, on the other hand, it is frequently asserted 
that distribution is " the true center of all economic inquiries," 
and it would be possible to treat nearly the whole of production 
from the standpoint of distribution. The truth is that these 
old traditional divisions of our subject matter indicate different 
points of view, and on this account it seems desirable to retain 
them. When we pass from production to distribution, we do 
not enter an entirely new field, but we look at an old field of 
investigation from a new point of view. 

The center of interest in the practical applications of economic 
principles has shifted from production to distribution. The mer- 
cantilistic writers of the seventeenth and eighteenth centuries 
were primarily interested in the most efficient ways of increasing 
the sum total of a nation's wealth. Even Adam Smith, as the 
title of his great work. An Inquiry into the Nature and Causes 
of the Wealth of Nations, indicates, had chiefly in mind the 
same problem, although he emphasized the fact that the real 
well-being of a nation consists in the well-being of the great 
body of its people. During the past century the production of 

384 



DISTRIBUTION AS AN ECONOMIC PROBLEM 385 

wealth has increased beyond all precedent, the chief factors 
contributing to this result being the factory system, the ex- 
ploitation of vast natural resources (iiade possible only by 
modern methods of transportation), and '.the free scope given to 
the initiative of the individual business man. Yet poverty 
still exists, and its harsh features are thrown into sharper relief 
by contrast with the fact that the present production of wealth 
per capita is indisputably the highest that the world has ever 
known. Moreover, while the social discontent arising from in- 
equalities in the distribution of wealth is a very old thing, it is 
only in modern times that democracy has given it an adequate 
opportunity for formulated, organized expression. A large 
share of the economic problems which are felt to press upon 
society today for solution relate directly or indirectly to the 
distribution of wealth. 

It should be noted, however, that we have to discuss under the 
name " distribution " two different processes. The first and 
inclusive meaning of the term is the distribution of the wealth 
or income of society among individuals and families; in other 
words, the question of individual fortunes, poverty, and wealth. 
The second kind of distribution is the apportionment of the 
product to the different factors of production. This is not a 
question of wealth versus poverty, but of wages versus interest, 
profits, and rent. Of course, this kind of distribution affects 
the personal distribution of wealth, but it is by no means the 
same question. To explain why lots in New York City com- 
mand high rents is one thing ; to explain why a large amount of 
these rents goes to the Astor family is another thing. In the 
case of wages, however, the two kinds of distribution amount to 
about the same thing. There is another sense in which the 
word is not used in this chapter. We do not mean by distribu- 
tion the moving of goods from the place where they are produced 
to the place where they are consumed. When we speak of 
railways or merchants as " distributive agencies," we are using 
the term " distribution " in a sense very different from that of 
the technical economic term " distribution." Distribution is a 
question of ownership, not a question of the location of goods. 

20 



386 OUTLINES OF ECONOMICS 

Distribution controlled by Existing Institutions. — The statement that 
distribution is a matter of ownership suggests at once the relation of private 
property to distribution. Individual wealth is, fundamentally, a sum of 
property rights. Every extension of property rights by society, as, for ex- 
ample, in permitting the private ownership of the rights to supply cities with 
water, electricity, or transportation facilities, extends the field of private 
gain and correspondingly affects the distribution of wealth. The income 
received by the successful manager of a municipal waterworks plant is un- 
doubtedly a very different thing from the income the same individual would 
receive if he were the owner of a franchise permitting him to conduct the 
business of supplying the city with water as a private undertaking. The 
policy of leasing, rather than selling, public lands, which has been adopted 
by some of the newer American states, is bound to have an appreciable, 
even if not a very important, effect upon the distribution of wealth. 

In the institution of inheritance we have an instrument which once in a 
generation redistributes the property rights in existing wealth. It is not 
strange that those who wish to limit or retard the growth of large individual 
fortunes have looked to the control and especially to the taxation of inherit- 
ances as a means to this end. Doubtless the prevalence of large landed 
estates in England is closely connected with the English law of primogeniture, 
just as the predominance of small holdings in France is in part due to the 
French law forbidding the disinheritance of any of one's children. 

Personal freedom, as a legally guaranteed institution, is also of funda- 
mental importance. The factors determining the income of the free work- 
ingman are very different from those determining the portion of the slave. 
It should be remembered, too, that the actual processes by which wealth is 
distributed are today largely controlled by the institution of contract. 
What rent, wages, or interest one gives or receives is no longer fixed mainly 
by custom, as in the Middle Ages, but is a matter of agreement between 
individuals. So far as society limits the right of contract, as in the case of 
legislation regulating the employment of women and children, it corre- 
spondingly affects the distribution of wealth. 

These fundamental institutions are discussed more fully elsewhere in this 
treatise. They are mentioned in this connection in order to emphasize more 
definitely the fact that the distribution of wealth takes place under the con- 
ditions imposed by the existing social order. Even the most radical advo- 
cates of greater equality in the distribution of wealth do not propose an 
arbitrary leveling down of fortunes. They direct their attacks against one 
or more of these fundamental institutions, such as inheritance, private prop- 
erty in land, or private property in production goods. Then there are many 
persons who are willing to accept the conditions imposed by the existing 
social order, as a field for the operation of competitive forces in wealth distribu- 
tion, but who object to monopoly and special privilege. This suggests that 
the forces bringing about distribution on the basis of the existing social order 



DISTRIBUTION AS AN ECONOMIC PROBLEM 387 

are in themselves amenable to social control. If those who secure the chief 
prizes in the economic struggle may plume themselves on the fact that they 
are the victors in a game that is open to all, it is none the less true that 
society laj^s down the rules of the game. 

A large part of the complex of institutions and regulations through which 
society controls distribution work smoothly and silently, their action, so far 
as society at large is concerned, being unconscious. It is only when obvious 
conflicts arise between some of the effects of this unconscious control on the 
one hand and present-day ideals of social welfare on the other hand, that the 
significance of any part of this fundamental institutional control becomes 
generally felt. It is not the least of the merits of the study of economics that 
it emphasizes the fundamental character of that part of the social control 
of wealth production and wealth distribution which lies below the horizon 
of social consciousness. 

Money Incomes. — If each family produced all that it con- 
sumed, as most families still do in part, there would be no 
problem of distribution, except whatever problems might arise 
respecting the factors determining the amount produced by each 
family. But since most men today are working in more or less 
specialized employments, and for money incomes, the fact is, as 
was suggested in a previous chapter, that distribution takes 
place through a process of price-fixing. Some men (manu- 
facturers, merchants, farmers) make a money income by selling 
goods for more than it costs them to produce them or to buy 
them from others, while other men (laborers, salaried employees, 
professional men, capitalists, landowners) get a money income 
by selling their services or by selling the use of their capital or 
land. In the first case, the money income takes the form of 
profits ; in the second case, it is wages, interest, or rent, as the 
case may be. 

A man's real income consists of the commodities and services 
that satisfy his wants ; and the extent to which his money in- 
come can be transmuted into real income depends on the prices 
of these things. One always has the option, of course, of in- 
vesting part of his money income in production goods rather 
than in consumption goods, thus giving up part of his present 
real income for a larger future income. However, since different 
men have to pay about the same prices for the same kinds of 
goods, a discussion of the factors determining money incomes 



388 OUTLINES OF ECONOMICS 

will be, ipso facto, a discussion of the factors determining real 
incomes, except as it is found that certain kinds of incomes are 
changed more readily to meet the conditions imposed by changes 
in prices than are other kinds of income. 

It is obvious that one person may be the recipient of more than 
one kind of income. The American farmer who owns the land, 
buildings, farm machinery, and live stock that make up his pro- 
ductive equipment, and who does part of his own work, is at the 
same time entrepreneur, landlord, capitalist, and laborer; and 
his income is made up of different proportions of profits, rent, 
interest, and wages. The net income of a tenant farmer, 
utilizing only borrowed capital, and employing only hired labor, 
would, on the other hand, consist entirely of profits. The 
economic analysis that seeks to determine the rules governing 
the apportionment of the annual dividend under the categories 
of profits, wages, rent, and interest, bears only indirectly upon 
the question of the personal distribution of wealth. The in- 
come that any individual receives depends primarily upon his 
efficiency and success as. a wage earner or as an entrepreneur, or 
upon the amount and the income-yielding capacity of the capital 
and land which he owns. His ownership of capital and land 
may have come about through the thrifty husbanding of por- 
tions of his income in previous years, or it may have come about 
through gifts or inheritance. 

The Law of Diminishing Productivity. — To explain the 
prices paid for personal services is to explain wages ; to explain 
the prices paid for the use of land and capital is to explain rent 
and interest. Certain special and distinguishing characteristics 
enter into the determination of each of these three classes of 
prices. The conditions governing the supply of labor are, for 
example, very different from the conditions governing the supply 
of land. Yet there are some fundamental facts that are common 
to all three classes of prices. The most important of these com- 
mon factors is the law of diminishing productivity. 

Assume as an illustration that a certain farm is cultivated by a 
farmer who uses only his own labor, together with a small amount 
of capital in the form of draft animals and agricultural imple- 



DISTRIBUTION AS AN ECONOMIC PROBLEM 389 

ments. Let us assume further that his land is devoted ex- 
clusively to the growing of one crop, — corn, for instance. His 
money income will depend on the amount of corn he can pro- 
duce and the prices he can get for it. At given prices he can 
increase his income only by increasing his product. 

But his product may be increased by the use of any one of a 
number of different methods. In the first place, he can hire 
a farm laborer to assist him. The two men, working together, 
will undoubtedly be able to get a larger product from the farm 
than one man could. In some cases they may be able to get 
double, or even, through the advantages of cooperation, more 
than double, what the farmer could produce working alone. 
More often, perhaps, the employment of the second man will 
not double the total product. However that may be, it is 
absolutely certain that if the farmer employs a third, a fourth, 
or even more men, he will sooner or later reach a point where 
it will be found that the employment of the last man has not 
increased the product as much as it was increased by the last 
previous laborer. That is, the addition of the third man may 
not have increased the product as much as the employment of 
the second man did, or the fourth man may not have increased 
the product as much as the third man did. 

This point is called the point of diminishing productivity,'^ for 
after this point is once reached it will be found that, save under 
the most exceptional conditions, each successive additional 
laborer will increase the aggregate product by an amount less 
than the last previous laborer added to it. This is not because 
of any differences in the laborers, whom we assume to be of 
equal efficiency. It means simply that as the productive possi- 
bilities of the farm with its equipment of capital become more 
fully exploited through more careful tillage, it requires in- 
creasingly greater efforts, in the form of still more careful and 
thorough tillage, to increase the product by a given amount. 

1 In some economic writings what is here called "diminishing productivity" 
is termed "diminishing returns." It seems preferable to reserve the latter term 
for its more familiar application to the phenomenon of the increasing expenses 
incurred in enlarging the total agricultural product under the pressure of a popula- 
tion growing in numbers or in wealth. 



390 OUTLINES OF ECONOMICS 

This is a fact of such common observation that it needs no statis- 
tical proof; although various agricultural experiment stations 
have made records of the effect of different degrees of thorough- 
ness of cultivation upon the yield of different crops. 

The Marginal Product of Labor. — One might imagine, at 
first thought, that after the point of diminishing productivity 
had been reached, it would not pay the farmer to hire additional 
laborers. But the only question that directly concerns the 
farmer in this connection is whether an additional laborer will 
" earn his wages," — that is, whether the added product will 
sell for enough to cover the additional expense incurred for wages. 
It will pay the farmer to extend his employment of labor up to 
the point where the addition of another laborer to the working 
force would increase the product by an amount too small to 
sell for enough to pay the wages of the laborer, and where the 
deduction of a laborer from the working force would decrease 
the product by an amount at least sufficient to pay the wages of 
the laborer. If the farmer stops short of this point, he is not 
making aU the possible profits; if he goes beyond it, he is 
cutting down his profits by employing labor which does not 
" earn its wage." The last laborer employed (not necessarily 
any particular laborer, nor the last in point of time, but merely 
any one laborer of the total number employed) is the marginal 
laborer, and the increase in the total product attributable to the 
marginal laborer (the part which would be lost if one less laborer 
were employed) is the marginal product of labor. If the farmer 
has estimated product and prices accurately, it will be found, of 
course, that the money value of the marginal product of labor 
will be approximately equal to the wages of the marginal laborer. 
Or, since the laborers are supposed to be of equal efficiency, and 
hence to receive uniform wages, the statement may be put in the 
broader and more significant form that wages and the marginal 
product of labor will tend to equal each other. 

The diagrams illustrate the principle of the diminishing productivity of 
labor, developed in the foregoing analysis. In Figure i the rectangle OM 
represents the amount of corn that the farmer could raise on his land if work- 
ing alone, with his given equipment of capital. The rectangle AN represents 



DISTRIBUTION AS AN ECONOMIC PROBLEM 



391 



the increase in the product effected by the addition of another worker. Simi- 
larly, BP, CQ, DR, and ES represent respectively the additions to the product 







N 


P 








M 
















Q 
















w 


{) 















O A B C D E F 

Fig. I 

resulting from the employment of a third, fourth, fifth, and sixth laborer. 
If DR bushels of corn — the increment in the product attributable to the fifth 
laborer — sells for about enough to pay the wages of one laborer, the farmer 
will refuse to employ the sixth laborer, while the employment of the fifth 
would be a matter of indifference. If the fifth laborer were employed, the 
proceeds of the sale of 
that part of the total 
product represented by 
the rectangle OERH 
would be used up in the 
payment of wages (in- 
cluding payment for the 
farmer's own work as a 
laborer), while the part 
of the product repre- 
sented by the small rec- 
tangles above the line 
HW would be left to 
recompense the farmer 
for the use of his land, 
for the interest on and wear and tear of his capital. If any surplus is left 
after these demands are satisfied, it would, of course, constitute the farmer's 
profits. If the conditions were as assumed, the fifth laborer would be the 
marginal laborer, and the product represented by the rectangle DR would 
be the marginal product of labor. 

If we were dealing with a very large undertaking, in which many laborers 
are employed, the successive rectangles representing the increments in the 




Fig. 2 



392 OUTLINES OF ECONOMICS 

product attributed to the hypothetical addition of successive laborers could 
be conceived as indefinitely narrow, so that the graphic representation would 
take the form represented in Figure 2, where the line AM is located at the 
point of diminishing productivity, and where the line BN represents the mar- 
ginal product of labor. In this case the rectangle OBHN represents the part 
of the total product which will just suffice to pay the wages of all the la- 
borers employed. 

The Marginal Products of Capital and Land. — Thus far 
we have supposed that the farmer is content to get along with 
his original amount of land and capital, and to increase his 
product by means of an increased use of labor. Other possibili- 
ties are, of course, open to him. It might happen that he would 
be content to do without additional laborers, using instead an 
increased equipment of capital. By purchasing more draft 
animals, more labor-saving machinery, improved fertilizers, or 
possibly by installing drains or irrigation ditches, as the case may 
be, he may be able to raise considerably more corn than he could 
without such investments. But here, again, he will find the 
possibility of increasing his product subject to the same limita- 
tions that would have prevailed had he increased his labor force. 
With a team of horses he will be able to accomplish more than 
he could with one horse ; two teams of horses may still further 
increase the total product of the farm ; a third would probably 
be of very little advantage, and a fourth team still less useful. 
So with investments- of capital in other forms : the law of 
diminishing productivity is a remorseless physical fact which 
the farmer has to reckon with. 

The concrete form in which the problem presents itself to 
him is this : Will a further investment of money in a specific kind 
of capital goods pay me? Here the farmer has to make on 
the one hand the best estimate he can of the amount which the 
proposed capital goods will add to his annual product, and of 
the probable selling value of the increased product. On the 
other hand, he has to count his increased annual expenses. 
These will include (i) the original cost of the additional equip- 
ment, divided into annual costs according to its probable dur- 
ability (each year's costs being properly only the wear and tear, 



DISTRIBUTION AS AN ECONOMIC PROBLEM 393 

or " depreciation " attributable to that year's use) ; (2) the 
maintenance or upkeep (including such things as ordinary 
repairs on machinery and the cost of feeding horses), and (3) 
the interest on the investment (what the farmer has to pay if he 
borrows the necessary funds from some one else, or what he 
might have lent his money for to some one else if he uses his 
own funds). Guided by these estimates, the farmer will 
naturally increase his equipment of capital goods so far as the 
returns from the added product would more than sufi&ce to 
cover his increased costs. Beyond this point he could not 
wisely go. The last increment of capital — which just sufl&ces 
to pay for itself — is the marginal increment of capital, and the 
added product attributable to it is the marginal product of capital. 

The diagrams portraying the operation of the law of the diminishing pro- 
ductivity of labor will serve as well to illustrate the diminishing productivity 
of capital. Assuming that the amount of land and the amount of labor to 
be utilized are definite in quantity, the successive rectangles in Figure i rep- 
resent the increase in the gross product attributable to each of successive 
increments of capital. Figure 2 represents the same conditions, except that 
each increment of capital is assumed to be indefinitely small. 

If (in Figure 2) BN represents the marginal product of capital, the whole 
return imputed to capital is, of course, represented by the rectangle OBNH. 
The area above the hne HN represents the part of the product which is avail- 
able for rent and wages, the farmer's profits being derived from any surplus 
that is left after these demands are satisfied. 

There is one difficulty in the foregoing analysis, however, that may have 
been noted by the reader. What is meant by an "increment of capital"? 
In the case of labor the "increment of labor" can be interpreted as the labor 
of one man ( for any definite period of time that may be chosen), the one man 
being assumed (for the purpose of simplicity in the analysis) to be of equal 
efficiency with all others constituting the labor supply. It is just as prac- 
ticable, of course, to assume that one horse is, for the farmer's purposes, just 
as efiicient as another horse, that only one kind of plow is available, and that 
one bushel of fertilizer is exactly like any other bushel of fertilizer ; but this 
does not help us out of our difficulty. For how can we blend horses, plows, 
and fertilizers into one concept, and divide them into "increments of capital ' ' ? 
One way of getting around the difficulty is to think of the capital which the 
farmer combines with his labor and his land in terms of its money value. In 
this sense an increment of capital might be a dollar's worth of capital, or ten 
dollars' worth of capital, without reference to the different kinds of concrete 
production goods really composing it. This device is useful for some pur- 



394 OUTLINES OF ECONOMICS 

poses, but it obscures the fundamental fact that capital gets its value from its 
ability to secure an income for its owner. The purpose of this analysis of 
diminishing productivity is to open the way for a discussion of the prices paid 
for the services of land, labor, and capital. To use the term " capital " in the 
sense of capital value at this stage in the discussion would only lead us into 
circiilar argument. This point cannot be further elaborated here, but should 
be kept in mind by the reader in connection with the discussion of interest in a 
subsequent chapter. As a matter of fact the law of diminishing productivity 
holds for each specific kind of capital the farmer uses. For example, imagine 
that the farmer is limited to the use of a fixed amount of all forms of capi- 
tal except one, — horses, for instance. Then the successive rectangles in 
Figure i would represent very well the increments of product gained by the 
use of additional horses, while if the product added by the use of a fifth 
horse is just about enough to pay for the increased expense, the rectangle DR 
would represent the marginal product. The illustration can, by a similar 
process, be made to apply to any other kind of capital. The farmer will 
normally make use of each specific kind of capital up to the marginal point. 
The same is true for 'each specific kind of labor or each specific use of labor. 
The use of the tripartite classification of the factors in production in 
explaining the principle of diminishing productivity is merely a matter of 
convenience. 

A third way of increasing his product is also open to the farmer. 
He may think it wiser to get along with his original equipment of 
capital and his own labor, and to increase his product by utilizing 
mofe land. The adoption of this procedure would mean a less 
intensive cultivation per acre of land. The use of labor and 
capital would have to be distributed more thinly over the larger 
acreage. This would result in a smaller product per acre, but 
the procedure would be warranted if the increase in the annual 
product should sell for more than the annual cost of the addi- 
tional acreage. By the annual cost of additional land we mean 
the rent which the farmer 4ias to pay for the land if he leases 
it, or the interest on the amount of the purchase price, if he 
buys it. It is obvious, however, that the combination of more 
and more land with a fixed amount of labor and capital will 
result in a smaller and smaller return per acre of land, and that a 
point will soon be reached beyond which it will not pay the 
farmer to go. In other words, the law of diminishing produc- 
tivity rules when land is considered as the variable factor, just 
as it does when labor or capital is considered as the variable. 



DISTRIBUTION AS AN ECONOMIC PROBLEM 395 

The diagrams already used may be adapted to the illustration of the present 
hypothesis by assuming that equal areas, if successively combined with a 
given amount of labor and capital, would yield increments of product as 
represented by the successive rectangles in Figure i , or by the curve in Fig- 
ure 2. It is assumed for the sake of simplicity in the illustration that the dif- 
ferent acres of land available for the farmer's use are of equal fertility. 

The Actual Operation of Diminishing Productivity. — It has 

been assumed thus far that the farmer of our illustration has to 
be content with a fixed quantity of two of the three factors in 
production, but that he is at liberty to increase his use of the 
third factor up to the point where maximum profits will be 
gained for himself. Assuming in turn that each of the three 
factors in production was the variable one, we found that in 
each case the law was the same — the most advantageous ad- 
justment was reached when the product added by the last in- 
crement of the variable factor would sell for just enough ^ 
to cover the increased expense. 

In one way, however, this assumption does not correspond 
with the facts. The farmer is at liberty to increase his product 
by increasing his utilization, not only of any one, but of any 
two, or all of the three, factors of production. He may, for 
example, purchase more draft animals and more machinery, 
employ more labor, and at the same time acquire more land. To 
a certain extent the use of one factor may lessen the use of 
another (as in the case of labor-saving machinery and labor). 
More often, however, the reverse is true. The acquisition of 
machinery may necessitate the use of more horses, while the 
acquisition of more land will often make profitable the use of 
more labor as well as more capital — a fact which is itself im- 
plied in the law of diminishing productivity. Although the 
employment of labor, capital, and land can thus be increased 
simultaneously, the significance of the law of diminishing pro- 
ductivity is in no wise diminished. The farmer, in deciding 
upon the purchase of a particular kind of capital good, has to 

1 Whether this last unit, which just pays for itself, will be added, is of course 
a matter of indifference. The margin is consequently sometimes called the "margin 
of indifference." 



396 OUTLINES OF ECONOMICS 

take into account his present and, to some extent, even his prob- 
able future supply of other kinds of capital goods, as well as of 
land and labor, before he can form a judgment as to the amount 
which the use of the particular capital good will add to his annual 
product. Moreover, he has to choose between additional 
investments in labor as against additional investments in land, 
or additional investments in different kinds of capital. But 
his effort to get maximum profits will lead him. to make those 
investments which promise to result in the greatest additions 
to his product. The result of this will be, normally, that each 
factor in production will be utilized up to the marginal point — 
the point where further utilization would add a product so 
small as to sell for less than the increased expenses. 

It is not only in agriculture that the law of diminishing produc- 
tivity is the fundamental thing in determining the proportions in 
which the factors of production are combined. Every manufac- 
turer has the option of using either relatively more machinery 
and relatively less labor, or relatively less machinery and rela- 
tively more labor in order to produce a certain quantity of 
goods. He may have to decide, also, between building a six- 
story factory covering an acre of ground, and a one-story fac- 
tory covering six acres of ground — ■ a problem which is paralleled 
by the farmer's problem of deciding between the cultivation of a 
relatively large acreage and the more intensive cultivation of a 
smaller acreage. The entrepreneur in every kind of undertaking 
has to decide as to the advisability of a particular investment in 
land, capital, or labor, with reference to the fundamental ques- 
tion, " Will it pay? " And the profitableness of any such in- 
vestment is always a matter of the cost of the unit of land, 
labor, or capital, as compared with the selling value of tlie 
quantity which it will add to the entrepreneur's total product. 

In order to achieve maximum profits, each entrepreneur will e^t- 
deavor, so far as is practicable, to apportion his use of land, labor, 
and capital so that the value of the increment of product attributable 
to the marginal unit of each class of productive agents will about 
equal its expense. 

The significance of the law of diminishing productivity in rela- 



DISTRIBUTION AS AN ECONOMIC PROBLEM 397 

tion to the distribution of wealth now becomes apparent. If a 
given class of laborers in a given employment receive like wages, 
their wages (being the same as the wages of the marginal laborer) 
will tend to equal the marginal product of labor. The expense 
incurred by the entrepreneur for any unit of a certain kind of 
capital goods will tend to equal the value of the marginal product 
of that particular kind of capital, goods. The rent which the 
farmer will pay for any acre of a quantity of land of uniform 
quality will tend to equal the value of the marginal product of 
land of that quality. But so far as competition works freely, 
different entrepreneurs in the same market will have to pay 
the same wages for the same kind of labor, the same price for 
the same kind of capital goods, and the same rent for the same 
kind of land ; and they will get the same prices for the same kinds 
of products. Moreover any one unit of the aggregate amount 
of a productive agent of any one kind employed at any one time 
may be deemed to be the marginal unit. So it is possible to 
state in more general terms that the money remuneration of 
each specific unit of the agents of production in production 
tends to equal the selling value of the amount of product depend- 
ent upon the use of that unit. 

It is not necessary for the validity of thi^ specific productivity 
theory of distribution, as it is called, that in any particular 
undertaking -at any given time the proportions in which the 
factors of production are actually combined should be adjusted 
with the nicety which the theory seems to imply. The amount 
of land which the farmer holds at any one time is apt to be fixed 
by his estimate of his future rather than of his present produc- 
tion, while custom, pride of ownership, and the chance of gain 
through an increase in land values (which is not to be confused 
with the motives guiding his activity as a producer) have their 
influence. Moreover, the size of the government homesteads 
into which a large part of the public domain was divided has 
had an important effect on the size of the farmer's holding in a 
large section of the United States. The average American 
farmer undoubtedly holds more land than he would if he were 
looking for maximum present profits. The practical problem 



398 OUTLINES OF ECONOMICS 

for him is apt to be how intensively he shall cultivate it : how 
much labor and capital he shall combine with it. That is, he 
is apt to use relatively more land and relatively less labor and 
capital than he would use if every additional acre of land used 
meant an additional expense for land. This conclusion is not 
altered by the fact that his land is probably not of uniform 
quality, and that some of it may not repay cultivation under 
present conditions. In a similar way the manufacturer builds 
his factory for the future, and may even equip it with a larger 
complement of some kinds of machines (such as boilers and 
engines) than present requirements justify. On the other 
hand, a sudden and probably temporary increase in demand 
for a product will be met by the manufacturers by the employ- 
ment of more labor (even at the high rate paid for overtime 
or night work) rather than by the installation of more labor- 
saving machinery, even though the latter might, in the long run, 
be more economical. In general, when considerations which 
take into account a period of years dominate, land and the more 
permanent forms of capital goods will be used more freely, labor 
and the less permanent forms of capital goods less freely. When 
short-time considerations are dominant, the reverse will be 
true. 

These limitations do not invalidate the law of the equality of 
the remuneration of the agents in production and the prices of 
their specific products any more than the fact that a feather 
does not fall through the atmosphere as rapidly as a stone invali- 
dates the law of gravitation. This law, like other economic 
laws, is the statement of a fundamental tendency, which, in 
this case, is bound up with the universal desire of entrepreneurs 
to get for themselves the largest possible profits. 

Marginal Productivity and the Prices of Production Goods. — 
The reader who has firmly grasped the concept of marginal 
utility will find that a recognition of some similarities in the 
rdles which marginal utility and marginal productivity play in 
the price process will help him to grasp the significance of the 
latter concept. The prices paid for specific units of consumption 
goods depend upon their relative capacity to yield an " in- 



DISTRIBUTION AS AN ECONOMIC PROBLEM 399 

come of satisfactions " ; the prices that will be paid for produc- 
tion goods depend upon their capacity to yield a money income 
to the entrepreneur. In the one case the law of diminishing 
utility is dominant; in the other case, the law of diminishing 
productivity. Just as we cannot speak of the utility of a com- 
modity in general, but only of the utility of particular concrete 
units of a commodity, so we cannot speak of the productivity 
of land, labor, or capital in general, but only of the productivity 
of particular concrete units of land, labor, and capital. The 
consumer is getting the maximum of satisfaction of his wants 
when the final dollar spent for one commodity satisfies just as 
intense wants as the final dollar spent for any other commodity, 
and he apportions his expenditures accordingly. The entre- 
preneur is not making maximum gains if his final expenditure 
for any one kind of productive agent adds more to his product 
than his final expenditure (of equal amount) for any other 
productive agent, and he tends to apportion his employment 
of land and of different classes of labor and capital accordingly. 
But it must not be supposed that the statement that the prices 
paid for land, labor, and capital tend to equal the value of their 
marginal products is a complete explanation of the valuation 
of the services of the factors in production any more than the 
principle of marginal utility is a complete explanation of the 
valuation of consumption goods. In fact, from one point of 
' view, marginal productivity itself depends upon the prices which 
the entrepreneur has to pay for the services of the factors in 
production. The prices of productive services are like the prices 
of vendible commodities in that each buyer (entrepreneur) 
and each seller (laborer, capitalist, landlord) has to buy and sell 
at prices which, being established by the aggregate demand and 
supply of the market, are beyond his own control. Yet this 
aggregate demand and supply is the net result of the decisions 
made by individual buyers and sellers with respect to the 
amounts which they will buy or sell at one price or another. 

The demand for the use of land, labor, and capital is ulti- 
mately a demand for their products — the goods that satisfy 
human wants. The entrepreneur's task is to anticipate and 



400 OUTLINES OF ECONOMICS 

meet this demand — a problem that takes the concrete form of 
producing goods that will sell for more than the expense of 
production. On the one hand he has to estimate the quantities 
which he can sell at certain prices ; on the other hand, he has to 
take account of the quantities which various units of land, 
labor, and capital will contribute to his product, together with 
the prices (rent, wages, cost of capital goods, and interest) that 
he has to pay for these units. Through his mediation the de- 
mand of society for want-satisfying goods becomes a demand 
for the services of certain quantities of land, labor, and capital, 
combined in certain proportions. And the principle that guides 
the entrepreneur's transformation of the community's demand 
for the products of land, labor, and capital into his own demand 
for the services of these factors in production is the principle of 
marginal productivity. The wages, rent, and interest that are 
actually paid for the services of the factors in production are the 
resultants of the demand of entrepreneurs, on the one hand, 
and of the supply of these factors on the other hand. The 
forces determining these prices are focused at the margin. 

The principle of marginal productivity is an illuminating way 
of stating the problem of the distribution of wealth, rather than 
a solution of it. Just how supply and demaiid operate in the 
case of each factor in production is a topic to be considered in 
later chapters. Just as utility is at the same tirne the cause and 
effect of price, so marginal productivity is at the same time the 
cause and effect of wages, rent, and interest. From one point 
of view it is seen that the competition of producers makes it 
necessary that specific units of land, labor, and capital should 
get a reward proportionate to the selling price of the amounts 
which they contribute to the social dividend; from another 
point of view it is equally clear that the necessary expenditures 
for land, labor, and capital are, in the long run, potent factors 
in determining the prices of the things that make up the social 
dividend. 

The Meaning of " Productivity." — Furthermore, we should 
not forget that the word " productivity " as used in economics 
(and generally in current discussions of economic topics) has a 



DISTRIBUTION AS AN ECONOMIC PROBLEM 401 

distinctly limited meaning. To digress for a moment in order 
to make the point clearer : In the theory of consumption we 
emphasize the fact that many of the most important human 
wants are satisfied by " free goods," which, simply because they 
are free, lie outside the proper field of economic investigation. 
But the enjoyment of these free goods is usually dependent 
upon the possession of economic goods. Air is a free good, — to 
any one who can demand the economic goods necessary to life. 
The glorious scenery of our national parks is a free good, — 
to any one who can afford traveling expenses and hotel bills. 
In general, the enjoyment of many of the finer pleasures of 
life, involved in the common human relations of an individual 
to his physical and social environment, are " free," but free 
only to the individual who can afford the leisure and the 
economic goods without which many of these " free " pleasures 
are impossible. 

For present purposes, however, the important point is that 
there are free production goods as well as free consumption goods. 
Nature furnishes some of these. The oceans and lakes furnish 
free pathways for commerce ; natural forces of all kinds are 
freely utilized by men in the work of production. But we do 
not call these things productive, because no part of the annual 
product is dependent on the utilization of any particular unit of 
them. In this technical sense the wind is not productive, but 
windmills are. In order to utilize the ocean we have to invest 
money in vessels and docks. We have to impute productivity 
to these things because they will not be furnished unless it is 
estimated that they will yield a remunerative income, and be- 
cause the annual product will obviously be reduced if they are 
not furnished. Much has been written about the " produc- 
tivity " of the Panama Canal. But we would have to impute 
productivity to the Strait of Gibraltar if England were able to 
charge a toll for its use! 

Somewhat analogous to these '^ free productive goods " is 
society's fund of accumulated knowledge of productive methods, 
— the heritage of centuries of economic evolution. This 
accumulated industrial experience is an infinitely more precious 



402 OUTLINES OF ECONOMICS 

possession than the existing store of productive goods. Compare 

the productive possibilities of a community of men possessing 
this knowledge, but forced to begin work absolutely without a 
ready-made stock of capital goods, with those of a tribe of 
savages suddenly and miraculously equipped with all the 
productive appliances of modern civilization. Yet this vast 
fund of productive knowledge, so far as it is common property, 
is not thought of as " productive." The social dividend is 
continually being increased as a result of the discovery of new 
natural forces, or new ways of harnessing and utilizing natural 
forces. Secrecy or government patents make it possible for 
those who first introduce these new methods of production to 
reap an income from the temporary advantage it gives to them 
as producers. For the time being these new methods themselves 
have to be regarded as " productive," although they contribute 
much more to the increase of the social dividend after they have 
become matters of common knowledge and use, and hence have 
ceased to be called " productive." Disinterested scientists, 
especially those in the employment of the government or of 
universities, have often given the results of their improvements 
in industrial methods freely to the world, thereby swelling the 
social dividend, but not reaping for themselves the pecuniary 
reward which goes to those who patent their improvements 
and thereby render them " productive." Moreover, many of 
the world's greatest advances in the technique of production 
have been made possible only by the patient researches of in- 
vestigators in the " unproductive " field of pure science, working 
solely for love of the work, and without hope of pecuniary 
reward.^ 

We impute productivity only to goods or services which are the 
objects of property rights or of analogous rights of control, — such 
as a man's power to dispose of his own labor. The fact is that 
just as the benefits of free consumption goods are bound up with 
the possession of larger or smaller quantities of economic goods, 
so the utilization of free productive agencies is possible only in 

1 See a note on this point in Merz, History of European Thought in the Nine- 
teenth Century, Vol. i, p. 92, note. The list there given could be greatly extended. 



DISTRIBUTION AS AN ECONOMIC PROBLEM 403 

combination with labor, waiting, and scarce and appropriable 
natural objects, — and these have to be paid for. We harness 
natural forces for the work of production, but we impute produc- 
tivity only to the harness. We continually learn better and 
better methods of doing our productive work, but we impute 
productivity only to the expenses involved in utilizing these 
methods, — not to the methods themselves. Productivity im- 
plies merely a relation of dependency between the amount of the 
product and the use of a particular unit of one of the agents in 
production. 

It is important that the reader should see the truth in the 
statement that the laborer, the landlord, and the capitalist get 
paid in proportion to their respective products. It is equally 
important that he should see clearly that there are definite ; 
limitations to the meaning and significance of the statement. ■ 

The statement that rewards tend to equal products has no ethical sig- 
nificance, and should not be interpreted as a justification of the present eco- 
nomic order, — and this for the following reasons among others : (i) That dis- 
tribution ought to be according to productivity is itself a debatable proposi- 
tion. Some socialists, for example, maintain that distribution according to 
needs is a higher ideal. (2) The ethical side of the problem of distribution 
relates to personal distribution, while the marginal productivity doctrine 
relates to the determination of the incomes going to the different agents in 
production. To state that the rent of an acre of land tends to equal the value 
of its product is not to say that the landowner has "earned" his income. 
The private receipt of rent depends upon such social institutions as private 
property and inheritance, and these have to be judged from the broad 
point of view of social welfare. (3) The efiiciency of the individual laborer, 
which is one of the things determining his productivity, often depends upon 
the opportunity he has had to "make the most of himself." But opportu- i^ 
nity depends largely on environment, and this in turn is to a large extent 
amenable to social control. (4) The amount of the marginal product of any 
one factor in production is itself a resultant of all the forces affecting the V-^ 
supply of all the factors in production and of all the conditions that affect 
their fitness to serve in the production of the things that consumers are 
demanding. (5) This theory is only a statement of a normal tendency. It 
does not, properly understood, conflict with the fact that such things as 
custom and other forms of economic friction and inertia, the higgling of the 
market, the conscious efforts of social classes to better their condition, 
imperfections in the monetary system, short-sighted selfishness on the one 
hand, altruism on the other, as well as the conscious social control expressed 



404 OUTLINES OF ECONOMICS 

in labor legislation, usury laws, and the like, all have important effects upon 
the incomes actually received by those who furnish labor, capital, and land for 
the work of production. Actual wages may differ from the normal wages 
measured by marginal product just as contractual rent may differ from 
economic rent. (6) We can imagine an economic order ver}^ different from 
the present one in which it would still be true that incomes would tend 
to equal products. If, for example, wages were arbitrarily increased 50 per 
cent by law, while one result would undoubtedly be an increase in unem- 
ployment, it would still be true that wages would tend to equal the marginal 
product of labor, or, rather, that the marginal product of labor would tend to 
equal wages. To attempt to avoid this difficulty by assuming that the 
present order, or a purely competitive order, is the "natural " order of things, 
is to beg the whole question in favor of the existing status. 

Social Aspects of Diminishing Productivity. — Since the 
entrepreneurs are only the intermediaries between society viewed 
as a body of consumers and society viewed as a body of pro- 
ducers, we may, for present purposes, leave them out of con- 
sideration, in order to fix our attention upon some of the more 
general results of the fact of diminishing productivity. 

If the number of laborers within the boundaries of a nation is 
increased by immigration, without a corresponding increase in 
capital or in the amount of land available for use, the result will 
be an increase in the total amount of goods produced, which 
means an increase in the amount of wealth produced per unit 
of land and capital, but (on account of the operation of the law 
of diminishing productivity) a decreased amount per laborer; 
a higher marginal product for land and capital, and a lower 
marginal product for labor; consequently, higher rent and 
higher interest, but lower wages. If the supply of capital within 
a country is increased, while labor and land remain constant, 
the result will be higher wages and higher rents, but a smaller 
remuneration for capital. Similarly, if the available supply of 
land be increased (as by improvements in transportation facili- 
ties), rent will absorb relatively less, and wages and interest 
relatively more, of the value of the total product. 

In a very real sense the same laborer is more productive in a 
country where land is relatively plentiful than in a country 
where land is relatively scarce. A laborer may gain no technical 



DISTRIBUTION AS AN ECONOMIC PROBLEM 405 

efficiency by migration from Europe to America, but the in- 
crement of product attributable to his work is apt to be con- 
siderably larger in the United States than it was in Europe. 
Here he really creates a larger product and earns a larger wage. 
The migrations of labor and capital from one region to another, 
or from one country to another, are guided by the endeavors of 
capitalists and laborers to get the maximum remuneration, — 
which will always be found where the price of the marginal 
product of capital or labor is a maximum. 

In a prosperous country it is apt to be the case that the supply 
of labor and the supply of capital are being increased simultane- 
ously, though not necessarily with equal rapidity, while more 
land is at the same time being made available through improve- 
ments in transportation. Save under such exceptional condi- 
tions of railway building as prevailed in the United States 
during the forty years following the Civil War, the available 
supply of land is apt to increase more slowly than the other 
factors in production increase. In general, the law of diminish- 
ing productivity wiU necessitate a continual increase in the 
proportion of the product set aside for the remuneration of 
each unit of the most slowly increasing factor in production ; 
while, of the other two factors, the one that increases more 
rapidly will receive, per unit, a relatively smaller and smaller 
proportion of the value of the total product. 

QUESTIONS 

1. Do you know of any instances where the distribution of wealth has 
been affected, directly or indirectly, by conscious social action ? 

2. Prepare tables or diagrams roughly illustrating the operation of the 
law of diminishing productivity in some industry with which you are familiar. 

3. Why is the same laborer more productive in America than in Europe? 
Is this a condition that will probably continue indehnitely? 

4. Why do lands in Belgium produce more per acre than similar lands in 
the United States? 

5. Is that fact that the average wheat crop per acre is larger in Europe 
than in the United States an indication that European agricultural methods 
are superior? 

6. Which is the more significant : product per acre or product per man? 

7. Why are twenty-story ofi&ce buildings not erected in small cities? 



4o6 OUTLINES OF ECONOMICS 

8. Can an entrepreneur increase his product indefinitely by using con- 
tinually larger amounts of all the agents in production ? 

9. What is the relation of the discussion in this chapter to the socialist 
contention that labor produces all wealth ? 

ID. Discuss the following statement : 

"Each man, taking account of his own means, will push the investment 
of capital in his business in each several direction until what appears in his 
judgment to be the outer limit, or margin, of profitableness is reached; that 
is, until there seems to him no good reason for thinking that the gains 
resulting from any further investment in that particular direction would 
compensate him for his outlay. The margin of profitableness is not to be 
regarded as a mere point on any one fixed line of profitable investment ; but 
as a boundary line of irregular shape cutting one after another every possible 
line of investment." Alfred Marshall, Principles of Economics, 6th ed., 
P- 356. 

REFERENCES 

Carver, T. N. The Distribution of Wealth, Chap. ii. 
Clark, J. B. The Distribution of Wealth, Chaps, vii-xiii. 
Commons, J. R. The Distribution of Wealth, Chap. iii. 
Davenport, H. J., Economics of Enterprise, Chaps, ix, x, xxiii, xxiv. 
Marshall, Alfred. Principles of Economics, 6th ed.. Book v, Chap, viii, 
Book vi. Chaps, i, ii. 



CHAPTER XX 
THE RENT OF LAND 

Rent is the price paid for the services of land. In common 
usage the meaning of the word is, however, much less exact. 
That which one pays for the use of durable goods of any kind 
owned by another is commonly called rent. The payment for 
the use of a house or a business building is, for example, counted 
as rent. We shall see that in this case the so-called rent really 
consists of two elements, — one a ground rent, or rent proper, 
the other capital rent. If this distinction seems fanciful, it is 
only because we are accustomed to see the two united under 
one ownership. But in most large cities separate ownership 
is common. Sometimes one man owns the land and leases it 
for a long term of years to another who erects buildings upon 
it, which, either with or without payment, become the property 
of the landowner at the expiration of the lease, unless it is 
renewed, and if it is renewed, the one who possesses the build- 
ing must frequently pay for it. Often, however, the separa- 
tion in ownership is permanent, the house owner paying per- 
petually an annual sum for the use of the ground. This is the 
case in Baltimore, for example, where ground rents are an 
important feature in the economic life of the city. In such 
cases the two kinds of income are very clearly distinguished. 

Some modern economists have extended the meaning of both 
rent and interest, using them as two different ways of describ- 
ing one form of income, rather than as two distinct kinds of in- 
come. This usage is based on the obvious fact .that the rent 
which a landlord receives for an acre of land may easily be com- 
puted as a certain rate of interest on the money value of the land, 
just as the amount earned by a machine may be viewed either 
as the rent of the machine or as interest on its money price. 

407 



4o8 OUTLINES OF ECONOMICS 

But we shall see later that the income from other production 
goods, while governed in part by the same laws that control the 
income from land, is also governed in part by very different 
laws. Without dwelling further upon this distinction at this 
stage of our discussion, let us remember that in the great ma- 
jority of economic writings the term " rent " means only an 
income derived from the ownership of land, and that it is used 
only in this sense in the following discussion. 

The Services of Land. — The first thing to be noted about 
land is its quality. Differences of fertility are familiar to every 
one, and depend upon what have been known as the " original 
and indestructible properties of the soil." An effort has been 
made by certain writers to minimize or deny the significance of 
this factor. It has been said that " soil " is not indestructible, 
that it may be exhausted or removed from land altogether, 
and that it may in turn be created by means of fertilization. 
These writers recognize in land no other indestructible property 
than standing room. This objection arises from the use of the 
word " soil " in a narrow sense. 

If by " soil " we mean only that thin top layer containing 
some elements necessary to plant life, it is true that this may 
be carted on or off at pleasure, that it may be wasted or replen- 
ished. But, granting this, there still remain many qualities 
of land which are indestructible and unproducible, and which 
so directly affect the productiveness of the land that we may not 
inappropriately call them " properties of the soil." Such a 
property is the conformation of the land. A steep, gravelly 
hillside will by no possible effort equal a plain in fertility. The 
north side of a mountain cannot be made to produce the same 
as the south side. Climate is not, to be sure, a " property of 
the soil," but it is an inseparable appurtenance oT the land, 
and upon it the productiveness of the land in large measure 
depends. The ownership of a piece of land carries with it the 
advantage of all the conditions which attach to that land. 
The expression, " original and indestructible properties of the 
soil," is inadequate and misleading; but it covers more than 
mere " standing room." 



THE RENT OF LAND 409 

We will, therefore, adopt another expression to explain what 
we mean by quality in land ; namely, the irremovable conditions 
affecting its productiveness. Of these its extent (standing room), 
its conformation, and its climate are essentially original and in- 
destructible. Others, such as are connected with the " soil " in 
the narrow sense, are not indestructible nor necessarily original, 
but they affect rent none the less. Fertility, even when arti- 
ficial, becomes essentially a property of the land. From the 
case where capital is embodied in land and entirely assimilated 
to it in character, we pass by insensible gradations to fences, 
barns, houses, etc., which more and more assume the character 
of capital as distinguished from land. It would be possible 
to restrict the term " land " to strictly natural or " original " 
land, and apply the term " capital " to all products, including 
the soils of old land. This would be a logical distinction, but, 
like so many logical distinctions, would be confusing. On the 
other hand, if we include under land all capital that has been 
incorporated in it, we must recognize that there is no absolute 
line of division between land and capital. Thus we are again 
reminded that distinctions in economics, as well as in practical 
life, are questions of convenience, and are good or bad accord- 
ing as they are more or less useful. 

The second great fact regarding land is location. On one side 
this is closely connected with climate. But a more distinct 
meaning of the word is situation with respect to markets. 
Everybody knows that land a hundred miles from market is, 
other things being equal, worth more than land a thousand miles 
from market. This, however, is a question of accessibility rather 
than of mere distance. Land may be far away and yet easy to 
reach, or near and difficult of access. Any change in the expense 
of transportation affects rents. The rents of England have 
been revolutionized by cheap ocean transportation, which has 
practically brought distant land very near to her shores. To 
this fact of location we must ascribe almost wholly the enormous 
rents paid for city lots. Here, again, transportation facilities 
powerfully affect rents. 

One important difference in the way quality and location affect 



4IO OUTLINES OF ECONOMICS 

rent must, however, be noted. The quality of a piece of land 
affects the amount of its physical product; it determines how 
many bushels of wheat or how many pounds of cotton it will 
yield with a given amount of cultivation. The location of land 
does not, it is true, affect the amount of its physical product, 
but it does affect the price of the product, since that varies with 
the expense of transporting the product to market. The money 
value of a piece of land to the user depends upon the money 
value of its yield, which is, of course, the number of units of 
products multiplied by the price per unit. Suppose a man 
owns two wheat farms of equal size, one in Dakota and one in 
Illinois. If the farm in Dakota produces thirty bushels of 
wheat to the acre, and it costs twenty cents a bushel to get it 
to the Chicago market, where wheat is selling at a dollar per 
bushel, while the farm in Illinois produces twenty-five bushels 
to the acre, and it costs four cents a bushel to get this to the 
Chicago market, the farms are equally productive so far as 
the owner is concerned, for in each case he will get $24 for an 
acre's yield of wheat. If the other conditions of production 
are the same, the farms are equally valuable to the owner. 
From the social point of view, too, one of the farms is as good 
as the other. For the costs of transportation, of moving things 
to where they are wanted, have to be counted among the legiti- 
mate and necessary costs of production. In short, we may say 
that the two pieces of land are equally good land. When we 
speak of good land, therefore, in connection with the subject 
of rent, we mean land which for all purposes taken together is 
desirable. 

Rent under Assumed Conditions of Uniform Intensivity of 
Cultivation. — The first settlers in a new country have no need to 
pay rent. They find plenty of land, and even the best of it will 
be a free good, like air or water. So long as any man can get land 
qf the best quality free, there is no reason why he should pay rent 
to any one else. But this fortunate state of affairs will last only 
so long as some of the best lands remain unoccupied. When 
increase in the population makes the utilization of inferior lands 
necessary, the owners of the better lands will be able to demand 



THE RENT OF LAND 



411 



and receive a rent for the use of their lands. This will be made 
clear by reference to Figure i, which is constructed on the 
assumption that there are six grades of land, A, B, C, D, E, 
and F, and that for all these lands the same amount of cultiva- 
tion per acre is necessary. The successive rectangles repre- 
sent the selling value of the product that can be raised on one 



B 



JJ 

Fig. I. 



JS 



F 



acre of each of these different grades of land, by the use of a 
fixed amount of labor and capital. The product of an acre 
of the best land, A, will sell for Oamy dollars. Until all of this 
best land is occupied, no rent will be paid, and the entire value 
of the product will be available for the expense of the capital 
and the wages of labor employed in its cultivation.^ 

As soon, however, as it becomes necessary to cultivate some of 
the B lands, the situation will be altered. The owners of the A 
lands can now exact a rent for their use, and the tenant farmer 
has no alternative, except to utilize land of the second grade, 
on which the fixed amount of labor and capital will only produce 
a product per acre selling for abnk dollars. The rent which 
will be paid per acre for A lands will amount to the difference 
between the value of the products of the two grades of land 
{hkmy in the diagram). For if the landowners attempt to charge 
more than this difference, tenant farmers will find it more 



1 The profits which the farmer may receive as entrepreneur do not affect the 
analysis, and may accordingly be neglected. 



412 OUTLINES OF ECONOMICS 

advantageous to use the B lands; if they charge less, the A 
lands will be the more remunerative to the farmer, and competi- 
tion among the farmers for the leases of A lands will force the 
rent up. In short, rent will normally be fixed at the point 
which will just equalize the advantages of cultivating the two kinds 
of land. 

As soon as increased population and the consequent need of 
a larger food supply and more raw materials have forced men to 
begin to cultivate lands of the C grade, the B lands will command ■ 
a rent, while the rent of the A lands will be increased by an 
amount equal to the rent of the B lands. And as cultivation is 
pushed down to still poorer and poorer lands, the rents which 
these better lands command will be still further increased. 
Thus, when some lands of grade E are in use, the value of the 
product which can be got from this free land, by the use of the 
fixed amount of labor and capital, will be dert dollars per acre. 
This sum will just about pay the cost of labor and capital, for if 
it amounts to less than these expenses of production, the E lands 
will not be worth cultivating ; if it amounts to very much more, 
it will pay to cultivate still poorer land. But if dert dollars 
will just pay wages and interest on the E lands, the same 
sum will pay wages and interest on the better lands, for we 
have assumed that the same amount of labor and capital 
is used on each grade of land. The expense for labor and 
capital will, therefore, be represented on each rectangle by 
the area below the line gt, while the area above this line will 
represent in each case the rent per acre which the landowner 
will receive. 

Rent, under these conditions, is a differential which measures 
accurately the superiority of the rent-bearing land over the mar- 
ginal land — the land which just repays the expenses of cultiva- 
tion. It is not necessary to the significance of the theory that 
all, or even any, of the farmers should be tenant farmers. If 
the farmer owns the land that he operates, the part of his income 
to which may be attributed the superiority of his land over an 
equal area of marginal land must, in any accurate analysis, 
be counted as rent. 



THE RENT OF LAND 



413 



Rent under Actual Conditions. — The conditions assumed in 
the foregoing analysis depart from actual conditions in one im- 
portant particular, — the assumption that equal amounts 
of labor and capital, that is, a \miform intensivity of cultiva- 
tion, would be used on lands of different grades. As a matter 
of fact, even after the A lands are all occupied, the supply of 
agricultural products can be increased without resort to poorer 
lands. All that is really necessary is the more intensive culti- 
vation of the A lands. This cannot be done, however, without 
encountering the law of diminishing productivity. Successive 
equal amounts of labor and capital used on the same lands 
cannot be expected to yield uniformly large increments of prod- 
uct. It will pay, however, to make use of more intensive culti- 
vation up to the point where the last unit of labor and capital 
adds barely enough to the prod- 
uct to pay for the increased 
expense, — a point which is called 
the intensive margin. The result 
of this more intensive cultivation 
is represented in Figure 2. Now 
the first rectangle in this diagram 
(Oamy) represents precisely the 
same thing as is represented by 
the first rectangle in Figure i, the 
return (in value of product) from 
the cultivation of an acre of land 
of A grade by the use of a fixed 
amount of labor and capital. The second rectangle in Figure 2, 
however, represents the additional product resulting from the 
use of a similar unit of labor and capital on the same acre, while 
the third represents the increment of product due to the employ- 
ment of yet a third unit of labor and capital on the same land. 
Assume that this third unit, A2, adds just enough to the selling 
value of the product to pay for itself. Then, as alread)^ ex- 
plained in the discussion of diminishing productivity, the area 
Ocph will represent that part of the farmer's income which will 
be used up by the expense incurred for the three units of labor 



Fig. 



A2 



414 



OUTLINES OF ECONOMICS 



and capital used on this one acre of land, and the area above 
the line hq will represent t-he real rent of that acre.^ If land E 
(Figure i) just repays the expenses of cultivation when one unit 
of labor and capital is used per acre, the value of the product 
per acre of this land will equal the value of the increment of 
product attributable to the third unit of labor and capital used 
on land A. (That is, the area dert, Figure i, equals the area 
hcpq, Figure 2.) So far, then, as the margin of cultivation is 
concerned. Figure i represents the conditions accurately. The 
productivity of capital and labor at the intensive and extensive 
margins is the same. 

But Figure i does not represent the complete theory of rent 
in that (i) it does not indicate the fact that larger quantities 
of capital and labor are used on the better lands than on the 

poorer lands, and (2) it 
does not represent the 
larger products due to 
this more intensive culti- 
vation of the better lands. 
These considerations are 
taken account of in Fig- 
ure 3, which also, by the 
substitution of curves for 
successive rectangles, 
represents the infinite va- 
riety of degrees of good- 
ness of the different acres 
making up the land sup- 
ply of a country. In Figure 3 the line am represents the money 
value of a product of a unit of labor and capital on the poorest 
land in use, and the area hmi represents what rent would be 
under conditions of uniform intensivity of cultivation. The area 
Oamg represents the diminishing amounts of labor and capital 
used per acre as we pass from the better to the poorer lands, 
while the area ymg represents the rent per acre of the different 
grades of lands. The foregoing analysis leads to the following 
1 Neglecting, for the present, the possible existence of profits. 




Fig. 3. 



THE RENT OF LAND 415 

Statement of the theory of rent, which the reader may verify 
for himself by referring to Figures i and 2 : 

The rent of any piece of land is measured by the difference between 
the money value of the products obtained from it by the use of the 
most advantageous amounts of labor and capital and the money 
value of the products which could be obtained by the use of the same 
amounts of labor and capital on marginal land, or at the intensive 
margin of cultivation. 

This statement should not be understood as comparing the 
total product raised on a given piece of land with the total prod- 
uct which could be got from the same amount of marginal land. 
This would be to reintroduce the assumption of uniform inten- 
sivity of cultivation — an assumption which impaired the ade- 
quacy of the theory of rent illustrated in Figure i above. On 
the contrary, it is assumed in the present statement that the 
farmer would use whatever amount of the marginal land he 
found most profitable. If it were profitable to use twenty 
times as much labor and capital on a certain piece of land as 
on a similar amount of marginal land, to employ the same 
amount of labor and capital profitably on marginal land would 
take twenty times as much land. 

Rent and the Marginal Product of Land. — In an earlier chapter it was 
suggested that rent could be measured by the marginal product of land ; in 
other words, that the amount which a farmer would pay per acre for the use 
of land would depend upon the money value of so much of his product as 
was dependent upon the possession of any one acre of land. In that dis- 
cussion it was assumed, however, that land was of a uniform degree of good- 
ness. Obviously, if all land really were of a uniform degree of goodness, in 
all ways equally desirable, no rent would be paid until all lands were utilized, 
when rent would arise on account of the necessity of increased intensivity of 
cultivation. 

But even under the actual conditions of the existence of different grades of 
land and of a large body of land which is below the margin of cultivation, 
the rent of any acre of the better lands can be stated in terms of the value 
of its product. For the rent of any acre of land is determined by the money 
value of the amount of the product imputed to it (as distinct from the product 
imputed to the labor and the capital employed upon it). Now the product 
that must be imputed to any acre of land is, of course, the amount which it 
adds to the total product, or, what amounts to the same thing, the amount by 



4l6 OUTLINES OF ECONOMICS 

which the total product would be decreased if just as much labor and capital 
were employed in agriculture, but if that particular acre of land were not 
available. This means, however, that the labor and capital which would 
have been employed on this land would have to be utilized either in cultivat- 
ing more intensively the lands already utilized or in cultivating lands pre- 
viously imcultivated ; that is, at either the intensive or extensive margin. 
Obviously the product imputed to the land in question would be the diiifer- 
ence between the total product got from it and the product which would 
result from the employment of the same amount of labor and capital at the 
margin. Thus, by a somewhat different line of analysis, we have again 
reached the statement of the theory of rent given in the preceding section. 

The Dififerent Uses of Land. — We have seen that the better 
lands will repay a more intensive cultivation than the poorer 
lands, and have found this fact to be of great significance in the 
theory of rent. By varying degrees of intensivity of cultivation 
we do not mean only the more thorough cultivation of the land 
in the raising of any one crop. Land produces a great variety 
of products, and some of these need much more intensive culti- 
vation than others. In the business of raising cattle, as it is con- 
ducted on a large western ranch, the total investment of capi- 
tal and labor may be very considerable, but the investment per 
acre of land is very small indeed ; while a small market garden, 
located near a great city, will repay a very high degree of inten- 
sivity of cultivation. It is only on the best lands that crops 
necessitating a large amount of labor per acre can be raised 
profitably. By the best lands we mean in this connection 
not only those lands which are best fitted by soil and climate 
for the production of particular crops, but the best lands in 
the sense that they are nearest the market. For example, 
cities in the eastern part of the United States get part of their 
supply of fresh vegetables from market gardens in their own 
environs, while another part of this supply may come from the 
southern states and even across the continent from California. 
The local market gardens are good lands on account of their 
situation; the more distant lands are good lands on account 
of special qualities of soil or climate which enable them to furnish 
" out of season " vegetables. 

Because certain lands are adapted, on account of quality or 



THE RENT OF LAND 417 

location, for intensive cultivation, they command high rents. 
On the other hand, lands which command high rents for alter- 
native uses generally have to be cultivated intensively, because 
the entrepreneur is forced by the very fact of high rent to econo- 
mize in his use of land as compared with his use of capital and 
labor. The raising of flax as raw material for linen is a profitable 
agricultural industry in densely populated Belgium, but it 
has never met with much success in the United States because 
flax straw of a quality fit for the better grades of linen demands 
a large amount of care and labor. Land is so plentiful here 
that it pays us better to specialize in a less intensive kind of 
agriculture — to spread our labor and capital more thinly over 
a larger number of acres. 

The poorest land that can profitably be used in the growing 
of any one kind of prodii^ct is not necessarily marginal land. 
Land too poor to use for market gardening may be good wheat 
land; land too poor to devote to wheat may be good grazing 
land. The poorest land devoted to any one purpose may 
yield a rent, arising from its relative superiority over other 
lands for some alternative use. It will be readily understood 
that the marginal lands used as a basis of comparison in 
our statement of the law of rent are the poorest lands used 
for any purpose — grazing lands, possibly. But, as we have 
seen, rent may also be measured from the intensive margin of 
cultivation, and the intensive margin is found on all lands, even 
the best. 

Although all our illustrations of the theory of rent have been 
drawn from agriculture, the principle is, in fact, perfectly gen- 
eral. The rent of land used for industrial or commercial pur- 
poses is determined in precisely the same way as the rent of 
agricultural land. In fact, different kinds of manufacturing, 
wholesale and retail trading, etc., may be looked upon as dif- 
ferent possible uses of land, differing in the amount of labor 
and capital they require, and all subject to the law of diminish- 
ing productivity, and hence to the law of rent. When we pass 
from the agricultural uses of land to its commercial and indus- 
trial uses, the fact of quality becomes of practically no impor- 



4l8 OUTLINES OF ECONOMICS 

tancc in the determination of rent, while the fact of location 
becomes fundamental. 

In addition to these different gainful uses of land, we have 
to take account of its other uses, such as for pleasure grounds 
and residence sites. Here the explanation of rent is simpler 
than in the case of productive lands. For these lands yield 
their utilities directly, and hence come under the general laws 
of price. 

The Capitalization of Rent. — To the individual who has a cer- 
tain amount of money for which he is seeking the most profitable 
use, the question whether he shall invest it in land or other forms 
of production goods is apt to be in itself an unimportant one. 
If he chooses to buy land, it will be because he can get a satis- 
factory income from it, and he will very properly count ' the 
income as interest on the funds he has invested in the land. If 
the income from the land increases, the selling value of the 
land will increase. From the point of view of our investor 
this will, of course, be an increase in the " capital value " of 
the land. It is important to note, however, that the land does 
not return an income simply because it is valuable. The process 
is the reverse of this. The land aids annually in the production 
of goods which command a price in the market ; a part of the 
money value of this annual product is necessarily imputed to 
the service of land and paid for in the form of economic rent; 
and the land is valued because it commands a rent. The money 
value of the land is governed by its income-yielding power. 

This fundamental fact is apt to escape our notice because in 
the United States lands are more commonly sold than leased, so 
that we think of the price of land as the price at which it 
will sell, rather than as its annual price, or rent, although the 
first kind of price depends upori the second. In England, 
where lands are more commonly leased, the price of land is 
usually thought of as its annual price or rent, while the selling 
price is often expressed as " twenty (or other number of) years' 
purchase," meaning twenty times the annual rent. The process 
by which the capacity to yield a certain annual income is made 
the basis for the determination of a certain selling price is termed 



THE RENT OF LAND 419 

" capitalization." ^ In a country which is growing in popula- 
tion and wealth, and where land rents are consequently increas- 
ing, the selling value of land is apt to be somewhat greater 
than a capitalization of the amount of income it is yielding at 
the time of the sale would justify. This is because the owner- 
ship of land carries with it the right to receive future as well as 
present incomes, and the prospectively larger future incomes 
are taken into account in the process of capitalization. 

Rent and Social Progress. — The fact just mentioned — the 
tendency of rents to increase as society progresses — is of very 
great significance. It springs from the impossibility of satisfy- 
ing the increasing wants of a society which is growing in popu- 
lation and wealth without increasing the supply of food products 
and raw materials by means of more extensive and more inten- 
sive cultivation. As this means pushing downward the exten- 
sive and intensive margins of cultivation, the necessary result 
is a rise in rents. 

During the early years of the nineteenth century the Napole- 
onic wars on the continent, together with a high protective tariff 
in England, kept England from importing any grain from 
Europe. This, coupled with a considerable increase in the popu- 
lation of England, resulted in very high prices for wheat, a 
rapid extension of cultivation, and a remarkable rise in rents. 
It was the effort of economists to explain these facts that led to 
the formulation of the theory of rent in substantially its present 
form. Bound up with this theory of rent was the law of dimin- 
ishing returns — the name usually given to the fact that an in- 
creasing population cannot supply .itself with food and raw 
materials except by the utilization of poorer and poorer lands, 
and consequently at an increasing expense per unit of product. 
(This law should not be confused with the law of diminishing 

1 The nature of this process of capitalization will be discussed in the chapter 
on Interest. It is a fact of common observation that the rate of capitalization, 
that is, the ratio of income to selling value, is lower in the case of land than in the 
case of most forms of capital goods. The durability of land, the variety of uses 
to which it may be put, the social prestige attached to land ownership, as well as 
the fact that, in many cases its income-yielding power is likely to increase, are among 
the things that accoimt for this. 



420 OUTLINES OF ECONOMICS 

productivity. One is a statement of a historical tendency in 
one field of production — agriculture ; the other relates to the 
proportions in which the factors of production are combined, 
and holds true for all fields of production.) 

This law of diminishing returns has been made the basis of 
many gloomy prophecies regarding the possibilities of a general 
and continued economic progress. Especially when this theory 
was combined with the Malthusian theory of population, which 
was based on the belief that population would tend to increase 
as fast as the food supply would permit, it seemed to point to 
insuperable barriers in the way of any considerable progress in 
human welfare. 

The history of the past century has belied these gloomy proph- 
ecies. The increase in population has been greater than in 
any previous period of the world's history, and yet, so far as 
agricultural lands are concerned, the general level of rents has 
not increased. In fact, the change has been in the other direc- 
tion. That rents have not increased as population has grown, 
does not disprove the law of diminishing returns. That law, 
like other economic laws, is true only as a statement of a tend- 
ency. If this tendency has not resulted in increased rents, it 
is not because it has not been operative, but because other 
powerful factors have counteracted its effects. Two things, 
at least, have prevented a rise in rents. In the first place, im- 
provements in agricultural methods have greatly increased the 
product which can be got from a given acre of land. We must 
include here not only improvements in methods of tillage and 
cultivation, in fertilizers, in the varieties of plants, in breeds 
of live stock, etc., but also organized social methods looking 
toward a better utilization of the nation's land supply, such 
as the irrigation of dry lands, and scientific forestry, which 
has an important influence upon the conservation of the 
rainfall. 

Of much greater importance, however, than all these things 
taken together, has been the revolution in ocean and land 
transportation, which has enormously increased the available 
amount of land. Lands in England have gone out of cultiva- 



THE RENT OF LAND 42 1 

tion because the railway and the steamship have brought the 
great wheat fields of America to her very doors. Even in the 
United States the new lands brought near to market by the rail- 
ways have often been of better quality than the lands previously 
cultivated, so that the margin of cultivation has gone up rather 
than down. There were 2,250,000 acres of improved farming 
lands in the state of New Hampshire in 1850; by 1900 this 
acreage had shrunk to 1,075,000. In Massachusetts the im- 
proved farm lands decreased in this period of fifty years from 
2,135,000 acres to' 1,300,000 acres. Similar figures could be 
given for others of the older states. The diminution in the use 
of old lands may be partly accounted for by their deterioration 
in fertility under continual cultivation without proper rotation 
of crops. But this is only a partial explanation, for any one 
who is familiar with the conditions knows that even the most 
careful tillage could not have kept millions of acres of farm land 
which were once rent-yielding from going below the margin of 
cultivation, for the simple reason that the margin of cultiva- 
tion rose. The railway practice of making very much lower 
rates per mile on long hauls than on short hauls has hastened 
this procesSj by minimizing the disadvantages of lands of good 
quality situated at a distance from the market. 

The fact that since the introduction of the railway the margin 
of cultivation has risen does not mean that it has risen continu- 
ously, or that it will continue to rise. There are many who be- 
lieve that we have only gained a brief and already passing respite 
from the day when every increase in the demand for food prod- 
ucts and raw materials will be met only with increasing diffi- 
culty. It is as dangerous to prophesy, however, as it was a 
hundred years ago. The fact that there still remain some 
unutilized lands of good quality in what are now out-of-the- 
way parts of the world may prove to be of less importance than 
other things. It is a striking fact that in the United States 
today only about half of the land actually in farms is culti- 
vated. Some of these uncultivated portions of farms are very 
poor lands, and others are given over to meadows and pastures. 
But we venture to say that what idle acreage exists is due in 



422 OUTLINES OF ECONOMICS 

part to a lack of correspondence between the historical condi- 
tions that have fixed the size of farms and the economic condi- 
tions that fix the number of acres that can be profitably utilized 
by one farmer. This unexploited area is, to that extent at 
least, a reserve which can be drawn upon as the demand for 
agricultural products increases. Then, too, we are just begin- 
ning to have some idea of the improvements which scientific 
selection may bring about in the qualities and productiveness 
of different kinds of plants ; methods of fertilization and tillage 
are still the subjects of fruitful scientific inquiry ; forestry and 
irrigation are yet in their infancy. Changes in demand, of 
such a nature as to make possible the utilization of some lands 
for the production of crops for which they are better fitted than 
for their present uses, are also among the things that may resist 
the tendency toward a general rise in rents. In fact, although 
it is absurd to suppose that the rent of land will not increase 
as society continues to increase in wealth and numbers, it is 
just as absurd to make this fundamental tendency toward dimin- 
ishing returns in agriculture a basis for pessimistic views regard- 
ing the possibility of economic progress. 

The Unearned Increment. — When we say that the margin of 
cultivation has gone up, rather than down, since 1850, we do not 
imply that rents have not, in many cases, increased. The new 
lands opened up to use by new railways, for example, are at first 
very cheap lands, often free lands. As they are taken up, they 
command higher and higher rents. Practically all of the agri- 
cultural lands now utilized in America have had such a history, 
— even though in some cases the present rents are not as high 
as their rents at some previous time. The fact that, through 
the change in transportation methods, the marginal farming 
lands of today are better lands than the marginal farming 
lands of sixty years ago does not affect the fact that the sum 
total of land rents, and consequently of land values, is immensely 
greater today than at any previous time. The increase in 
the value of land which accompanies the increase in its income- 
yielding power is often called the unearned increment. This 
phrase suggests that the increase in land values cannot be 



THE RENT OF LAND 423 

attributed to any special effort on the part of the owners of 
land, but is due to general social causes. 

This does not mean that the land-owning farmer cannot in- 
crease the selling value of his farm by wise investments of 
capital ; but, remembering that rent is the payment for the 
irremovable conditions affecting the productiveness of land, 
it is clear that it can be affected only to a comparatively small 
degree by the efforts of any one individual landowner. Most 
of the present money value of land has grown out of that 
complex of things which we call general social progress, the 
most important of which in this connection are growth in popu- 
lation and growth in average wealth — the things that lead to 
an increased demand for the products of the soil. We should, 
however, be careful to distinguish the rise in the sum total of 
rents which springs from the occupation of new and often better 
lands, and the increase in rent per acre, which comes from forc- 
ing downward the margin of cultivation. 

Despite these facts, the phrase unearned increment is mis- 
leading. As generally used, it implies a confusion of two very 
different things, — physical quantities (acres) and selling val- 
ues. From the fact that land is, in a physical sense, rarely 
" produced " it is inferred that the selling value of land is 
always " unearned." Other forms of wealth, it is sometimes 
urged, are valuable (command a high price) because they are 
produced at a cost ; land has no " expenses of production," 
and is valuable only because there is a demand for land and for 
its products. Now the reader should be able to see that this 
is not an altogether accurate way of stating the case. Produced 
goods, like land, are valuable only because people want them 
and are willing to pay for them. Other things have to be paid 
for because otherwise it will not be worth while for any one to 
go to the expense of producing them ; land commands a price 
because its supply is naturally limited, and because there are 
competing users of land who can apportion the available supply 
among themselves only on the basis of prices and rents corre- 
sponding with the advantages which particular units of land 
give to their possessors. 



424 OUTLINES OF ECONOMICS 

And so far as the increase in land values can be foreseen, 
it can rarely be " unearned." For the increase in the selling 
value of the land will be taken into account and discounted. 
This occurs in two ways. In the first place, the present 
selling value of such land will be higher than that of other 
property with similar annual income-yielding power. Usually 
both the seller and the buyer of land will take into account 
the probable increase in its selling value and will count this 
as an additional gain or profit attached to the possession of the 
land. In other words, the expected increment in value will be 
translated into terms of present worth, and added to what 
would otherwise be the present selling value of the land. The 
increment, so far as it can be foreseen, has to be paid for. In 
the second place, it is often incorrect to consider the expense 
of buying and holding land as a thing apart from the other 
expenses and gains of the business enterprise in which the land 
is used. The man who builds a house to let takes into account, 
(i) the expense of acquiring the land, (2) the expense of build- 
ing the house, (3) taxes and repairs, (4) the probable ultimate 
depreciation of the rental value of the house, (5) the probable 
appreciation in the rental or selling value of the land. It is 
common in such operations to assume that the fourth and fifth 
factors roughly offset each other. Most of the " free " land 
distributed under the Homestead Act was acquired by men who 
would have thought their expected incomes, outside of the 
probable increase in land values, insufficient to justify them in 
acquiring and improving the lands. Any one who has watched 
the settlement of western states and the growth of American 
cities knows that an enormous amount of effort and sacrifice 
has been put into improvements on land which would not have 
been put forth if the anticipated increase in the value of the 
land itself had not been counted on as part of the earned 
reward. 

There are unearned increments, — unexpected and undis- 
counted increases in the values of land, and, for that matter, 
in other capital values as well. But there are " unearned decre- 
ments," too. The extent to which these really unearned incre- 



THE RENT OF LAND 425 

ments are, in the aggregate, offset by unexpected and undis- 
counted shrinkages in land values and other capital values is 
a matter upon which we have, as yet, no adequate information. 

An American reformer, Henry George, converted a large following to his 
view that all taxes should be levied upon land values. This scheme, known 
as the "single tax," proposes that economic rent shall go to the government 
in lieu of taxes — a proceeding which would amount to the government 
ownership of land, and is so understood by its adherents. The merits and 
defects of the single tax as a scheme for raising public revenue will be con- 
sidered in another place. Here we are concerned with it simply as a scheme 
of economic reform. Henry George's main argument was based on the 
alleged tendency of land to absorb all the value due to "improvements in the 
productive power of labor." Among these improvements in the productive 
power of labor he included such diverse things as "the growth of population, 
the increase and extension of exchanges, the discoveries of science, the march 
of invention, the spread of education, the improvement of government," etc. 
"Land being necessary to labor, and being reduced to private ownership, 
every increase in the productive power of labor but increases rent — the 
price that labor must pay for the opportunity to utilize its powers, and thus 
all the advantages gained by the march of progress go to the owner of land, 
and wages do not increase." 

In the first place, we maj^ object strongly to the assumption that improve- 
ments in methods of production necessarily mean improvements in the "pro- 
ductive power of labor" — -an assumption which, like the socialists' labor 
theory of value, really begs the whole question. It would be just as reason- 
able to call these things improvements in the productive power of capital 
or improvements in the productive power of land. In the second place, we 
must enter an emphatic denial to the statement that "all the advantages 
gained by the march of progress go to the owner of land." If the supply of 
labor is increasing more rapidly than the supply of land, it is probable that 
rent per acre will increase faster than wages per laborer ; but this does not 
preclude an advance in wages. 

It must be remembered, too, that Henry George did not propose to abolish 
rent — an obvious impossibility — but simply to do away with the private 
receipt of rent. This would prevent the withholding of land from use for 
purely speculative purposes; thus increase the available supply of land, 
and consequently lower rents. That such would be the immediate restilt of 
throwing all land open to use cannot be denied. But in the long run it would 
probably have little effect on rent, as it would simply lead to a more rapid 
exploitation of the land. Land ownership, like any other institution, has 
to be judged from the viewpoint of general social interests. The "pride of 
ownership," as an incentive to accumulation and as a basis for good citizen- 
ship, cannot be lightly put aside. 



426 OUTLINES OF ECONOMICS 

Urban Lands. — In the modern city we have a tremendous 
mass of land values resulting from the concentration of a large 
population on a relatively small area.^ All are familiar with 
the narrow limits set upon the wholesale districts, the shopping 
districts, and the financial districts in American cities. The 
residence districts to which the greatest social prestige attaches 
are apt to be quite as narrowly restricted. Improvements in 
rapid transit facilities enlarge the residence areas that are uti- 
lized by people with moderate incomes, but only serve to increase 
the congestion in the business centers. Much has been said 
in favor of the special taxation of city land values. Movements 
in this direction have already gained great strength in Europe. 
If such taxes are to be justified, however, it must be primarily 
on grounds of fiscal convenience. In urban lands, as elsewhere, 
there are true unearned increments and true unearned decre- 
ments, but it would be going altogether too far to name the.whole 
mass of urban land values, enormous as it, unearned increment. 

QUESTIONS AND EXERCISES 

1. Malthus and Ricardo differed as to whether rent is an addition to the 
total income of society. What is the correct view? 

2. An accepted doctrine of taxation is that landowners cannot shift a tax 
on land values to any one else (as the tax on toabcco is shifted from the 
manufacturer to the consumer). Explain this on the basis of the theory 
of rent. 

3. "Rent does not enter into the determination of normal price." Ex- 
plain the meaning of this statement. 

REFERENCES 

Carver, T. N. The Distribution of Wealth, Chap. v. 

George, Henry. Progress and Poverty. 

HuRD, R. M. The Principles of City Land Values. 

Marshall, Alfred. Principles of Economics , 6th ed., Book vi, Chaps, ix, x. 

PiERSON, N. G. Principles of Economics, Vol. i, Part i, Chap. ii. 

Ricardo, David. Principles of Political Economy and Taxation, Chap. ii. 

Walker, F. A. Land and its Rent. 

1 The assessed value of land, exclusive of improvements, in the city of New York, 
amounted in 1907 to over three and a half billions of dollars — an amount nearly 
twice as great as the assessed value of all the real estate, including improvements 
in the state of New York outside of the city. 



CHAPTER XXI 
THE WAGES OF LABOR 

Wages constitute the price paid for the services of labor. 
Under the head of " labor " we include all the various kinds of 
personal services for which a payment is made. Professional 
men and salaried employees are wage earners in the economic 
sense, though the term is by common usage generally restricted 
to manual laborers working for daily or weekly payments. 
There is, however, in society to-day, as every one recognizes, 
a '' laboring class," marked off by lines that are fairly distinct, 
and including the great body of day laborers, factory hands, 
agricultural laborers, men in various trades requiring various 
degrees of intelligence and skill, employees in manor positions 
in business and mercantile establishments, and the like. Some 
of the most important and pressing present-day economic 
problems — the variety of things that make up what is often 
called the " labor problem " — relate to the economic position 
of this class. On this account it becomes of special importance 
to ascertain just what the rules are that determine its share 
in the national dividend. In the discussion of wages, then, we 
have in mind primarily the income of the " laboring class," 
although most of the principles that will be developed apply 
just as accurately to the other incomes that must be classed 
as wages in the economic sense. 

Wages as the Price of Labor. — The definition of wages 
already given suggests at once the most important fact about 
them : they are the prices paid for particular kinds of services, 
and hence come under the general laws of supply and demand. 
So far as the wages of any one kind of labor are concerned, we 
can say, as we did of the prices of commodities, that they will 
tend to be fixed at the point where the supply of that kind of 

427 



428 OUTLINES OF ECONOMICS 

labor and the demand for it are in equilibrium. But, as was 
found in the discussion of the prices of commodities, this simple 
statement does not take us very far into the analysis of the 
problem. We want to know why the supply of labor and the 
demand for it are what they are. We shall find, too, that the 
factors governing the supply and demand of labor are in some 
respects very different from those governing the supply and 
demand of commodities. 

The Demand for Labor. — The demand for labor is, in the 
last analysis, a demand for the products of labor. Labor does 
not command a price on its own account, but because it aids in 
the production of things that satisfy human wants. But how 
can we measure the product of labor ? How can we distinguish 
it from the shares in the total product that are to be attributed 
to land and capital ? We cannot say that the product of labor 
is to be measured by the dift"erence between the total product 
produced by the cooperation of labor, land, and capital and the 
product which would be produced by land and capital working 
alone; for this last would, of course, be zero. The fact is, as 
we have seen in a previous chapter, that the proportion of the 
product that is attributed to labor is determined by the prin- 
ciple of specific or marginal productivity. 

That is, v/e cannot think of the " product of labor," except 
as the product of the individual laborers making up the supply 
of labor, and the product of any individual laborer is actually 
and exactly the amount which he adds to the total product 
of land, labor, and capital ; in other words, the amount by 
which the total product would be decreased if the labor of this 
individual laborer were not utilized. The social demand for 
the products of labor, which is the basis of the entrepreneur's 
demand for labor, is not a demand for any vague abstraction 
like the " product of labor in general," but is a demand for 
the concrete products due to the activities of individual 
laborers. 

We must note also that in the case of labor, as in the case 
of commodities, the word '' demand " must not be taken in a 
loose, indefinite sense. The demand for commodities means 



THE WAGES OF LABOR 429 

the quantities that will be taken at certain definite prices. 
The demand for labor does not mean anything unless it is 
understood to refer to the number of laborers that will be em- 
ployed in a particular occupation at a certain wage. In a 
given occupation at a particular time wages might be fixed 
at any one of a large number of different possible points. The 
higher the wage, the smaller will be the number of laborers 
that an entrepreneur can afford to employ; and that for two 
reasons : In the first place, the higher wages mean higher 
expenses of production, and consequently higher prices will have 
to be charged for the product — a fact which will reduce the 
quantity of the product that can be sold on the market, and 
consequently reduce the demand for labor. In the second 
place, higher wages for labor will induce entrepreneurs to 
economize in the use of labor, and to use relatively more land 
and capital, according to the principles which have been ex- 
plained in the discussion of diminishing productivity. The 
demand for any particular kind of labor is thus influenced 
both by variations in the demand for the products of that 
particular kind of labor, and in the proportion of the product 
that can be attributed to labor rather than to land and capital. 
In a similar way the elasticity of the demand for any kind of 
labor — the extent to which variations in wages will affect the 
quantity of labor utilized — is a complex function, being affected 
not only by the elasticity of the demand for the particular 
products produced by this kind of labor, but also by the readi- 
ness with which more capital or more land, or both, can be 
substituted for labor, as labor becomes higher priced. In the 
printing industry, for example, a rise in wages would make it 
profitable for employing printers to use more labor-saving ma- 
chinery, such as typesetting and linotype machines, automatic 
press feeders, and the like. The higher the wages of agricul- 
tural laborers, the more profitable will be the more extensive, 
as compared with the more intensive, uses of land. On the 
other hand, the reader will at once think of many trades, such 
as plumbing, where machinery cannot be substituted for hand 
labor, and where, consequently, the only elastic element in the 



430 OUTLINES OF ECONOMICS 

demand for labor lies in the elasticity of the demand for the 
products of labor. 

The Efect of Labor-saving Machinery on the Demand for Labor. In what 
has just been said about the use of machinery as a substitute for labor, we 
have had in mind only the effect of changes of wages on the relative amounts 
of labor and of capital that would be used in any one branch of production. 
Quite another problem, and one of great social importance, relates to the way 
in which the demand for labor is affected by new inventions and by the 
introduction of new machine processes. The laborers themselves have often 
looked at such innovations with hostility. When machinery first began to 
be used extensively in the woolen industry in England, this opposition wa.s 
expressed in riots in which the new machines were destroyed, as weU as in 
"proposals to impose legislative restrictions on the use of machines, so as to 
bring them to a level with hand work, and prevent them from doing the work 
more quickly or more cheaply than it could be done by hand." ^ In many 
instances laborers still are inclined to view the introduction of labor-saving 
machinery as an economic injury to themselves. On the other hand, there 
are many persons who claim that this attitude on the part of the laborers is 
an evidence of shortsightedness, since the inevitable result of machine pro- 
duction is to cheapen the prices of products and thus to lower the cost of 
living, the net result being an increase in real wages, as contrasted with 
nominal or money wages. 

This view emphasizes an important truth, and yet it misses the real 
point of the laborers' alleged grievance. It is true that while the first result 
of the introduction of improved methods of production is often to bring 
larger profits to those who introduce them (especially if the new methods are 
protected by patents), their benefits are ultimately diffused throughout 
society at large in the form of the fuller and better satisfaction of wants, and 
the laboring class, as members of society, share in these advantages. But 
while it is thus true that such improvements ultimately redound to the benefit 
of laborers as a class, it is equally true that hardship to many individual 
laborers is often an immediate result of the introduction of labor-saving ma- 
chinery. Especially is this true in the case of skilled workmen in highly 
specialized employments, who sometimes find themselves suddenly deprived 
of the advantages of their skill, — gained often by long years of apprentice- 
ship. To expect that such men will feel that they are compensated for their 
personal loss by the advantages ultimately accruing to laborers as a class, 
is to ask too much of the altruistic elements in human nature. Workmen 
have learned, however, from the experience of the past huijdred years, that 
the introduction of machinery is inevitable, and in the better-organized 
trades they are in many cases pursuing the wiser course of trying to regulate 
the conditions of the introduction of new kinds of labor-saving machinery 

1 Cunningham and McArthur, English Industrial History, p. 226. 



THE WAGES OF LABOR 431 

in such a way as to diminish the hardship inflicted on individual workingmen. 
Thus, when the linotype machine began to displace hand compositors in the 
printing trade, the typographical union was able to secure the retention of 
many hand compositors as linotjqie operators, together with a reduction 
in the length of the working day. 

It should be noted also that the effect of the introduction of machinery 
upon the demand for labor varies in different industries, the most important 
factor in this connection being the elasticity of the demand for the products 
of the particular trade affected. In the case of the linotype just mentioned, 
the lessened cost of composition made it possible for newspapers greatly to 
increase their reading matter, so that the actual reduction in the number of 
employees was small compared with what might have been expected. The 
introduction of machine methods into the Enghsh textile industry during the 
period of the Industrial Revolution furnishes an instructive example. The 
change in the methods of manufacturing cotton cloth came just as the in- 
vention of the cotton gin had greatly increased and cheapened the supply of 
raw material. This, coupled with the decreased cost of manufacturing, so 
cheapened cotton cloth (which had previousl)^ been very expensive) that its 
use was largely increased. In fact, a great many more persons were em- 
ployed in spinning and weaving cotton soon after the Industrial Revolution 
than immediately before it. In the woolen industry, however, there was no 
such immediate increase in the sale of the product, so that many workers 
were displaced, and had to seek occupations where their specialized skill was 
of no avail. Especially when the occupation affected is a highly specialized 
but relatively unimportant one in a series of processes comprised in the 
manufacture of a product the wage-earning power of the displaced laborers 
is apt to be seriously diminished. 

The Supply of Labor. — It is when we fix our attention 
upon the nature of the supply of labor that differences be- 
tween the way in which wages are determined and the way in 
which the prices of commodities are determined become most 
noticeable. 

In the first place, if we view industry in general, we notice 
that in the case of labor there cannot be much difference between 
the actual supply and what we called, when discussing excha.nge 
value, the " potential supply." Labor is in this particular 
like the most perishable of commodities : the number of work- 
ing days in a man's life is limited, and those that are not sold 
are irrevocably gone. The laborer has, it is true, some power 
in the way of " holding out for higher wages," but even this 
power is limited rather narrowly by the absolute necessity of 



432 OUTLINES OF ECONOMICS 

making a livelihood. In the long run small wages are better 
than none. The sale of labor is often a forced sale. 

In the second place, the fact that labor is inseparable from 
the person of the laborer has important results. When the 
laborer enters into an agreement to work for wages, he not 
only sells his labor, but he gives up a certain amount of control 
over his own life ; he agrees to live and work under conditions — 
often unpleasant ones — set for him by others ; he accepts, in 
short, all the environment of his task, as well as the task 
itself. 

Connected to some extent with this last fact is a third differ- 
ence — the relative immobility of labor. Commodities may 
always be sent to the market where they will command the best 
price, but the laborer is restrained by family ties, patriotism, 
differences in language, customs, and religion, ignorance, and 
the like. The result is that variations in wages as between 
different countries or as between different localities in the same 
country are much greater than similar variations in prices. 

The Relation of the Structure of the Population to the Supply 
of Labor. — We are apt to take it for granted that the supply 
of labor in different countries and localities depends primarily 
on the numbers of the population. This is, of course, funda- 
mentally true, but we must also note that the structure of the 
population is a variable thing, and one that affects the supply 
of labor. Over four fifths of the persons employed in gainful 
occupations in the United States in 1910 were males — a fact 
which suggests that the relative proportions of the sexes in 
the population have an important effect on the supply of labor. 
There are more males than females in the population of the 
United States, while the reverse is true of most European coun- 
tries, this difference being due in large part to the excess of 
males among our European immigrants. There are important 
differences in this respect between the individual states. Males 
constitute nearly two thirds of the population of Montana 
and less than 'one half of the population of Massachusetts. 
The age composition of the population must also be taken into 
account. The United States census of 1910 showed that nine 



THE WAGES OF LABOR 433 

tenths of the persons engaged in gainful occupations were be- 
tween 15 and 65 years of age — comprising what is sometimes 
called the " productive age group." A larger proportion of the 
population of the United States is between these ages than is the 
case in most European countries — a fact which is due to the 
large number of foreign-born adults in our population. In most 
European countries a larger proportion of the population is of 
" productive age " than is true for the native population of the 
United States. In considering the effect of these natural group- 
ings of the population upon the supply of labor, we have to also 
take account of differences in the nature of industries, in national 
or local customs, and in the presence or absence of legal restric- 
tions, — all of which affect the number of women and children 
who can be counted as part of the available supply of labor. 
Many observers have suggested that the frequent holidays 
found in the Latin countries of Europe form an appreciable 
obstacle in the way of the industrial development of those 
countries, as they materially diminish the real supply of labor. 
The supply of labor is not, however, merely a matter of the 
number of available laborers ; it is also conditioned by their effi- 
ciency. The physical strength and vigor, industry, intelligence, 
ingenuity, and moral qualities of the laboring population deter- 
mine the amount and kinds of work they can do. These things 
vary greatty as between different races and as between different 
individuals of the same race. They are not entirely a matter of 
heredity, for they can be influenced greatly by the physical and 
social environment. So far as high wages mean more and better 
food, and improve the other conditions of living, they tend to in- 
crease physical and mental efficiency, and thus to increase the 
quantity and better the quality of labor that can be got from a 
given population. There may often be, even when we take only 
production into account, a real economy in high wages. ' Public 
education and public activity in regard to such matters as pure 
foods, hygienic conditions in homes and in factories, and oppor- 
tunities for wholesome recreation tend to increase the efficiency 
of labor, and might be justified on this ground. The right view, 
however, is that such things would be justified on their own ac- 



434 OUTLINES OF ECONOMICS 

count, as tending to raise the level of human living, even if they 
did not increase human efficiency. 

The Relation of the Growth of the Population to the Supply of 
Labor. — Just as the potential supply of commodities at any 
given time is determined largely by past conditions, so the 
potential supply of labor at any given time is to a very large 
extent predetermined. Subject to the limitations which have 
been mentioned in the preceding section, the supply of labor 
is a matter of the numbers of the population, and the factors 
affecting the growth of the population are, from the long-time 
point of view, the most important things determining the supply 
of labor. 

Most of the discussion of these factors has centered around 
the Malthusian theory of population — the doctrine that popu- 
lation tends to increase faster than the food supply, and is 
only held back by the actual pressure of famine and disease 
(arising from an insufficient food supply), or by the prudential 
motives which restrain men from undertaking the responsibility 
of marrying and raising families upon incomes insufficient to 
provide the necessities of life. Just what the first part of this 
doctrine means can be made clear by referring to the conditions 
in a country like India, where the population presses so closely 
upon the food supply that any considerable failure in the rice 
crop is sure to result in famine and starvation. Every increase 
in the food supply is followed there by an increase in the birth 
rate and a decrease in the death rate ; every diminution in the 
food supply is followed by a decrease in the birth rate and an 
increase in the death rate. The frequent famines in India, 
which have been charged by some ignorant or prejudiced ob- 
servers to neglect or incompetence on the part of the British 
government, are, in fact, absolutely unpreventable, so long as 
these conditions prevail. 

When, however, we fix our attention upon the United States, 
or England, or any country possessing Western civilization, 
we notice some things that do not seem to harmonize with the 
Malthusian theory. The population does not press so closely 
upon the food supply that any widespread suffering follows a 



THE WAGES OF LABOR 435 

season of poor crops. Poverty seems to have but little restric- 
tive effect on the birth rate, which is generally higher among 
the poorer classes than among the well-to-do. Such facts have 
been cited by critics of the Malthusian theory, some of whom 
have been inclined to credit it with very little economic sig- 
nificance. Yet when we take a broader view of the facts, they 
appear in quite a different light. 

The best estimates indicate that England did not have over 
five and a half million inhabitants in 1630, and yet overcrowding 
at home was one of the reasons commonly given for the policy 
of colonization which England was undertaking at that time. A 
hundred years later, despite the growth of industry, and of 
foreign and domestic trade, as well as some important improve- 
ments in agricultural methods, the population had increased 
to only about 6,200,000. In 1761, on the eve of the Industrial 
Revolution, the population is estimated to have been about 

-6,700,000.^ By 1 83 1, when the factory system was thoroughly 
established (although England was still trying to raise most 
of her own food supply), the population had more than doubled, 
amounting to about 14,000,000. Since that time England 

. has developed her manufacturing and commercial interests, 
but has imported a larger and larger proportion of her food 
supply and raw materials from newer countries, where land is 
cheaper. The latest census of England (191 1) showed a popu- 
lation of 36,000,000. There is no explanation of this remark- 
able growth in the population of a country which was " over- 
crowded " in 1630, other than the obvious one implied in the 
fact that the opening up of new countries and the improvements 
in transportation have enormously increased the world's supply 
of food products and raw materials — a considerable portion 
of which England has been able to get for herself through the 
development of those commercial and manufacturing activities 
in which her early start, her situation, her coal and iron mines, 
and her own necessities, have given her a preeminence. 

The total population of all Europe in 1760 was probably not 
over 130,000,000. In 1915 it was about 450,000,000, some 
1 For these estimates, see Census of Great Britain, 1850, Vol. ii. 



436 OUTLINES OF ECONOMICS 

200,000,000 of this increase having taken place since 1820, and 
about 150,000,000 since 1872. Account must also be taken of 
about 125,000,000 persons of European origin or descent living 
outside of Europe at the beginning of the twentieth century. 
Moreover, wherever this European expansion has carried West- 
ern civilization and industrial methods, the numbers of the native 
population have more often increased than decreased.^ Such, 
for example, is the case in Mexico, South America, the Philip- 
pines, Java, India, and Egypt. For at least a hundred and fifty 
years before the opening of Japan to Western civilization its 
population had remained nearly stationary. Since 1871 it has 
increased from 33,000,000 to approximately 53,000,000 (1915). 
The probability that this great increase in that part of the world's 
population which has adopted modern industrial methods 
has come about by a decrease in the death rate rather than by 
an increase in the birth rate does not alter the significance of 
the fact that these improved methods of production and trans- 
portation have operated like the release of a spring,^ allowing 
the natural tendency toward the increase of the population 
to work itself out more fully. 

In view of these facts it is impossible to deny a large amount 
of significance to the Malthusian theory of population. Popu- 
lation has generally increased wherever the increase in wealth 
has afforded it opportunity. Yet it does not follow that the 
Malthusian theory is, in its strictest interpretation, true. Popu- 
lation has not increased as rapidly as wealth has increased. 
Average real incomes are very much higher than they were 
before the Industrial Revolution — a statement that holds 
true for average real wages as a particular form of income. 
Interpreted in the light of the principle of diminishing produc- 
tivity, this means that population has not increased so rapidly 
as capital and the available supply of land have increased. If 
there had been no increase in population during the last one 

1 W. F. Willcox, "The Expansion of Europe in Population," ^werzcow Economic 
Review, Vol. v, p. 749. 

2 This figure was applied to the effect of an increase in wealth upon the growth of 
the population by Sir James Steuart, in his treatise on Political Economy (1767). 



THE WAGES OF LABOR 437 

hundred and fifty years, the marginal productivity of labor would 
(if, nevertheless, modern methods of production had been de- 
veloped) have been very much higher than it is, and wages 
would have been correspondingly higher than they are. 

The Subsistence Theory of Wages. — The doctrine that 
wages tend, in the long run, to equal a bare subsistence, was a 
theory advanced by English economists in the first quarter of 
the nineteenth century as a coroUary of the Malthusian law 
of population. Said Ricardo: "The natural price of labor 
is that price which is necessary to enable the laborers, one with 
another, to subsist and to perpetuate their race, without either 
increase or diminution." Granting the premises, the logic 
was incontrovertible : If wages fall below this level of subsist- 
ence, the result will be, in the long run, fewer laborers and there- 
fore higher wages. If the increase in wages goes beyond the 
level fixed by the cost of subsistence, the result will be, accord- 
ing to the Malthusian doctrine, more laborers and therefore 
lower wages. The cost of subsistence in this view formed the 
" expenses of production " of labor, and the actual wages 
determined by supply and demand were supposed to fluctu- 
ate around these normal wages as the market prices of commodi- 
ties fluctuate around the normal prices fixed by the expenses 
of production. Socialists and advocates of the single tax have 
made much of this theory of wages as proving the impossibility 
of bettering the condition of the laboring class under existing 
conditions. By some socialists this doctrine, in its most rigid 
form, has been called the " iron law of wages." But socialists 
and followers of Henry George alike have to face the difiiculty 
of accepting this theory and at the same time rejecting the theory 
of population on which it rests — a theory which they cannot 
accept, for its truth would obviously place insuperable obstacles 
in the way of any lasting improvement in wages being achieved 
through the adoption of their schemes. The subsistence theory 
of wages, if true, would hold just as true under socialism or under 
the national ownership of land as under existing conditions. 

It should be said that the subsistence theory of wages was in 
part a reflex of the conditions actually existing in England at the 



438 OUTLINES OF ECONOMICS 

time. Wages were very low, and the law required that deficien- 
cies in wages, below the amount necessary for the maintenance 
of the laborer and his family, should be made up out of parish 
funds — a provision which in itself tended to keep down wages, 
and was made still worse by the fact that the allowance for 
maintenance to each family was proportioned to the size of the 
family, thus encouraging the rapid increase of the population. 

The Relation of the Standard of Life to the Supply of Labor. — 
Whatever may have been the case in the past, the subsistence 
theory of wages does not square with the facts of today, for the 
amount paid in wages is obviously considerably more than is 
" necessary to enable the laborers to subsist and to perpetuate 
their race, without either increase or diminution." Ricardo 
himself did not give to the " minimum of subsistence " the fixed 
and rigid meaning which some socialists have attached to it. 
It varied, he recognized, with the habits and customs of the 
people. In this more elastic form the " minimum of subsist- 
ence " shades into what is termed more accurately the " stand- 
ard of life." The number and character of the wants which a 
man considers more important than marriage and family constitute 
his standard of life. Whenever wages fall below a point where 
the standard of life can be maintained for a family, the work- 
man will do without the family and maintain the standard of 
life for himself alone. While the increase in the quantity of 
goods produced that has taken place by reason of the industrial 
revolution and the utilization of new and vast bodies of natural 
resources has been attended with an unprecedented increase 
in population, it has also been attended with an improvement 
in the standard of living. Every advance in the standard of 
life marks a step definitely gained in the economic progress of 
the laboring class ; it affords a vantage ground for yet farther 
progress. 

This is not only because the standard of life is, by very defini- 
tion, a fundamental factor in determining, in the long run, the 
supply of labor, but also because experience has shown that 
the standard of life affords an element of strength to laborers 
in their bargains with employers. Any encroachments on it 



THE WAGES OF LABOR 439 

are met with strong and determined resistance. Moreover, 
a high standard of life is, as we have seen, one of the things that 
make for productive efficiency on the part of the laborer, and 
hence tend to increase his earning capacity. Many persons 
who are deeply interested in the welfare of the laboring class 
believe that the wisest philanthropy is embodied in the efforts 
that are made to raise the level of living. Among such efforts 
are included such things as the work of social settlements, 
public and private movements to secure better conditions of 
housing, municipal expenditures for places of public recreation, 
for public libraries, for such things even as clean and well- 
lighted streets ; and, above all, public education. 

The extent to which the possibility of attaining a still higher standard of 
Hving operates as a restraining force upon the increase of the population is 
largely determined by the extent to which democratic ideals are realized 
in the social organization. It is a noticeable fact, for example, that the first 
generation of immigrants to the United States bring with them the habits and 
ways of living of their European homes. So long as simple standards of life 
are retained in connection with the larger incomes which they are able to 
earn in this country, more of them are able to marry ; they are able to marry 
earlier, and they can raise larger families. But the second generation grows 
■ up in an American environment. They attend our public schools, where they 
mingle with American children and receive an American education. The 
possibility of taking a social and economic position higher than that of their 
parents is opened up to them. They become saturated with the American 
notion that each man has a chance to climb to the top of the ladder. They 
find here no rigid barriers separating social classes from one another. "Like 
father, like son " may have been true in Europe ; here it has no binding force. 
Hence the birth rate among our native population of foreign parentage is 
very much lower than the birth rate among our foreign-born population. 

The Supply of Labor in Different Occupations. — Just as the 
demand for labor on the part of entrepreneurs is not a demand 
for " labor in general," but a demand for specific kinds of labor, 
so the supply of labor is the supply of laborers who are able and 
willing to do certain definite kinds of work. The supply of labor 
in any given occupation is, at any given time, almost as rigidly 
fixed as is the supply of labor in general. Laborers can usually 
change from one occupation to another only at the loss of the 
advantage of whatever specialized skill they may have acquired. 



440 OUTLINES OF ECONOMICS < 

This is, however, a matter of occupations, not of industries. 
There is, for example, a wide range of industries open to a skilled 
mechanic or a stationary engineer. But in the skilled trades 
what variability there is in the supply (at any given time) comes 
less from any possibility of passing from one trade to another 
than from the opportunities the more efi&cient and ambitious 
workmen have of entering business on their own account (that 
is, of becoming entrepreneurs) or of entering some calling where 
general ability, rather than specialized skill, is the prime requi- 
site. The carpenter may become a contractor ; the skilled 
mechanic may become a traveling salesman, and this, very 
likely, in some line where his specialized skill will still be of 
some advantage. The options thus open to the stronger mem- 
bers of each group should not be lost sight of in any considera- 
tion of the forces tending to resist a downward movement in 
the wages paid in any occupation. 

Throughout the greater part of American history the most im- 
portant option of this kind has been due to the existence of a 
large body of free land. The mobility of labor in this country 
has been such that it has been impossible for wages to fall much 
below the amount which a man could make for himself by tak- 
ing up government land on the frontier. Today, however, 
we are confronted by a different set of conditions. The frontier 
has completed its journey across the continent, and there 
remains for the settler only such land as irrigation may reclaim 
from the arid regions of the West. The wage earner will hence- 
forth be without the strong support of the economic alternative 
of a living got from free land. 

When we take the long-period point of view, we find more elas- 
ticity in the supply of labor in particular occupations. The 
ranks of each trade are being continually depleted by old age, 
death, and, to some extent, by the alternatives open to its 
stronger members. These gaps need not be filled by an incom- 
ing body of apprentices if the wages paid are lower than the 
wages in other occupations demanding a similar degree of prep- 
aration and ability. But there is a certain amount of inelastic- 
ity even here, for a variety of reasons, among which we may 



THE WAGES OF LABOR 441 

note : (i) the habit of imitation, which leads a boy to enter the 
same occupation his acquaintances have chosen ; (2) the not in- 
frequent tendency of sons to enter their father's occupation; 
(3) lack of knowledge or of early appreciation of the relative 
advantages of different employments, and (4) the fact that only 
a small number of options may be open to the residents of a par- 
ticular territory. These facts, in turn, have an important bear- 
ing upon the localization of industry, for industries are apt to 
be located in places where there is a present and prospective 
supply of specially skilled labor. 

Differences in wages, together with other factors just men- 
tioned, are not, however, the only considerations which attract 
laborers to different occupations. Many economic writers 
have observed that there are differences in the wages paid in 
different employments which are out of all proportion to any 
differences in the training or the ability they require. Adam 
Smith enumerated five circumstances which " make up for a 
small pecuniary gain in some employments, and counterbalance 
a great one in others." These are : " I. The agreeableness 
or disagreeableness of the employments themselves ; 11. The 
easiness and cheapness, or the difficulty and expense, of learn- 
inj them; III. The constancy or inconstancy of employment 
in them ; IV. The small or great trust which must be reposed 
in those who exercise them ; and V. The probability or improb- 
ability of success in them." These circumstances need expla- 
nation in two particulars : First, the agreeableness or disagree- 
ableness of an employment is very often a matter of the social 
standing attached to it. Many men are doing clerical work 
to whom some kind of physical exertion would be both more 
pleasant and more profitable, but who dislike to be classed 
among the "manual laborers." So-called "professional pur- 
suits " attract many men to whom more lucrative opportunities, 
requiring less special preparation, are open in other employ- 
ments. In the second place, the significance of these circum- 
stances is affected by the fact that the most poorly paid (because 
the least efficient) laborers are found in the most disagreeable 
and the most uncertain employments. 



442 OUTLINES OF ECONOMICS 

The Wage Contract. — The wages that a laborer actually 
receives are determined by an agreement between himself and 
his employer. Here appear again those '' gains of bargaining " 
which were mentioned in the discussion of the prices of commodi- 
ties. But in the case of the wage agreement, if the bargain is 
between an employer and an individual workman, the advan- 
tage is likely to be very largely on one side. The employer is 
apt to know pretty accurately what he can afford to pay the 
laborer ; he knows about how much the laborer will add to his 
product, and his knowledge of business conditions helps him to 
estimate the value of this added product. He knows what it 
would cost him to get his added product in other ways, as by 
paying some of his present employees for " overtime " work, or 
possibly by speeding his machinery faster. Moreover, there 
is the possibility, or even probability, of getting some other 
laborer, in case he fails to come to an agreement with the one 
in question. His experience as an employer of laborers will 
help him to gauge the minimum that the laborer will accept. 
With the laborer the situation is very different. He can gauge 
with less accuracy just how much his services are worth to the 
employer. The minimum wage that he will accept will be 
governed by his very limited power of holding out for higher 
wages, or by his estimate of what he can get in other emplo}^- 
ments — very few of which may be open to him. The whole 
situation may be expressed by the statement that it is usually 
a matter of small importance to the employer whether or not 
he secures a particular laborer, while the securing of a particu- 
lar employment is often a matter of the very greatest importance 
to the laborer. Under these conditions wages are apt to be 
fixed much closer to the minimum which the laborer will take 
than to the maximum which the employer will pay. Where 
laborers can bargain in groups rather than as individuals, their 
disadvantages are greatly lessened. The fundamental motive 
underlying the development of labor organizations has been to 
secure the advantages of collective bargaining. 



THE WAGES OF LABOR 443 

QUESTIONS AND EXERCISES 

1. How far are wages determined by the productivity of labor ? In what 
different ways do wages affect the productivity of labor? What meaning, 
or meanings, do you attach to the word "productivity" in the foregoing 
questions ? 

2. Why are the wages of men higher than the wages of women in the same 
employments ? 

3. Make a short outline, or table, of the factors determining the supply 
and demand of labor. 

4. Are wages paid as a reward for the irksomeness of labor? Are they 
paid on account of the scarcity of labor ? 

5. Some economists have held that "a demand for commodities is not a 
demand for labor." Discuss this statement. 

REFERENCES 

Carver, T. N. The Distribution of Wealth, Chap. iv. 

Clark, J. B. The Distribution of Wealth, Chaps, vii, viii. 

Davidson, John. The Bargain Theory of Wages. 

Fetter, F. A. Principles of Economics, Chaps, xx-xxvi. 

Flux, A. W. Economic Principles, Chap. viii. 

Marshall, Alfred, Principles of Economics, 6th ed., Book vi. Chaps, i— v. 

Taussig, F. W. Wages and Capital. 

Thompson, H. M. The Theory of Wages. . 



CHAPTER XXII 
LABOR PROBLEMS 

Types of Labor Organizations. — There are at least three 
distinct types of labor organizations : the Trade Union, repre- 
senting a combination of wage earners in a single trade or two or 
three closely related trades ; the Industrial Union, composed of 
all kinds of wage earners working in a given industry ; and the 
mixed Labor Union, made up of wage earners from many trades 
and many industries. Thus, the Brotherhood of Locomotive 
Engineers, strictly a trade union, makes no attempt to include 
other workers in the railway service ; the United Mine Workers, 
however, an industrial union, attempts to combine all persons 
working in and around the mines ; while the Knights of Labor, 
in the period of its strength and prosperity, fused all sorts and 
conditions of workers in some of its district assemblies, and 
combined these assemblies in a closely knit, highly centralized 
national labor union. 

The difference in the structure of labor organizations colors 
their policies and gives rise to important problems. The trade 
and industrial unions are, as we should expect, much more 
homogeneous, and therefore much more efficient than the labor 
unions, but they are likely to be narrower in their aims and more 
selfish in their policies. The labor unions, on the otjher hand, 
have in the past proved much less efficient, much more unwieldy 
and much more disposed to make use of cooperation, political 
action, and other devices which are not suited to associations of 
wage earners, or at least not easily handled by them. 

For the larger and more general objects common to wage 
workers as a body, many of the American unions have combined 
in a large, loosely knit confederacy, known as the American Fed- 
eration of Labor. This organization interferes just as little as 

444 



LABOR PROBLEMS 445 

possible with the constituent unions, and confines its activity to 
securing favorable labor laws, organizing trades in districts of the 
country in which trade unions have heretofore failed to get a 
start, rendering assistance to unions which are hard pushed in 
strikes or other disputes with employers, encouraging the use of 
union-label goods, and, in short, to furthering all those interests 
which labor organizations have in common. The membership 
of the American Federation of Labor in 1914 was a little over 
two millions. 

The Economic Justification of Labor Organizations. — The 
question is often asked why labor organizations are necessary, 
in view of the fact that wages are fixed, at least within broad 
limits, by deep-lying economic and social forces which the labor 
organization cannot effectively control. If wages depend upon 
demand and supply, it is said, what excuse for the troublesome 
and irritating trade union ? 

The answer is in part that economic laws work themselves 
out through men and through organizations — they are not self- 
enforcing. We have had labor organizations of one kind and 
another ever since the wage system existed, and we shall un- 
questionably continue to have such organizations unless the 
wage system is superseded by something more satisfactory. 

Even if we grant that labor is in essentials a commodity whose 
price is fixed by demand and supply, there is still a reason for the 
labor organization. The supply of labor is largely controlled, 
in the long run, as we have seen, by the standard of life ; and 
one of the great functions of the labor organization is to 
strengthen and advance the standard of life. If a great horde 
of unorganized and unsympathetic wage earners are continually 
bidding against one another in the labor market, each individual 
endeavoring to get a little more work by offering to take a little 
less pay, the standard of living will be subtly undermined, "nib- 
bled away," as a well-known writer has expressed it. The labor 
organization, by repressing the vicious activity of this competi- 
tion, by compelling its members to offer the same terms and abide 
by common or standard rules, bulwarks the standard of life, and 
gives it increased precision, increased power and durability. In 



446 OUTLINES OF ECONOMICS 

addition, most unions endeavor to exercise a more direct and 
positive influence upon the supply of labor, by limiting the 
number of apprentices, helpers, and other persons entering the 
trade. These efforts, however, are not always successful. 

Current economic doctrine recognizes at least one other legiti- 
mate function of the labor organization. In an advancing or 
progressive state of industry there must often be some margin 
between the price of what the laborer — under direction — 
produces and the wages he gets for producing it. The employer 
cannot always pay the worker the whole price of that part of the 
product which might be imputed to the worker's efforts ; if he did, 
he would, in many cases, have only what, in another chapter, we 
have called " minimum " profits. By stout resistance and skill- 
ful bargaining it is often possible for the wage worker to get a 
part of that share of the product which would otherwise go to 
the employer as profits. Of course, that labor organization will 
be most successful in the long run which increases the produc- 
tivity of its members, and thus creates a larger product to be dis- 
tributed among all the factors of production. But even if the 
organization does not increase the productivity of its members, 
it has a chance to improve their wages by trenching upon profits. 
Mere bargaining, therefore, despite the operation of more 
fundamental economic forces, is still exceedingly important. 
And the unorganized wage workers, being poor bargainers, com- 
bine with their fellow-workmen, not only to maintain a more 
uniform price for their labor, but in order to procure the guidance 
and assistance of an expert bargainer — the business agent or 
walking delegate. The labor organization is thus a commercial 
institution for the sale of labor in large quantities ; its primary 
function is collective bargaining. 

Labor Organizations and Monopoly. — It is plain that the 
labor organization as a wholesale jobber of labor is essentially 
a product of those familiar economic forces making for large-scale 
commercial dealings ; it is brother to the trust, akin to the com- 
bination, and thus not untainted with monopoly. One of the 
most searching criticisms directed against the labor organization 
is that it exhibits all the evil tendencies of monopoly. The 



LABOR PROBLEMS 447 

charge has some elements of truth. The ultimate aim of the 
average labor organization is to induce every worker in the 
industry to join the union, so that by monopolizing the supply 
of labor it may control the price. But in its principal implica- 
tions the charge of monopoly is misleading, because the great 
majority of unions do not attempt to limit the number of their 
beneficiaries. They aim to increase wages, but they are willing 
and even anxious that every member of the craft should share 
the increase. It is rare for a labor organization to exclude from 
its ranks a number of workers and then persecute them by refus- 
ing to work with them or treating them as scabs. Conflicts 
with non-union men are common, but in a very large majority 
of cases every effort has been made to get these men into the 
union. An organization which is constantly exhorting its com- 
petitors to come into the combination and share its benefits 
is at most an inclusive monopoly, and is not to be confused with 
the exclusive monopolies found in the field of business. 

Methods and Policies of Labor Organizations. — The aims of 
labor organizations and the policies employed to achieve their 
ends vary in accordance with the conditions of the occupation or 
industry in which their members work. Some unions, for in- 
stance, lay great emphasis upon apprenticeship ; and if they thus 
secure control of the supply of labor in the trade, find it necessary 
to place but little dependence upon strikes and boycotts. On the 
other hand, organizations like the Brotherhood of Locomotive 
Engineers find this question settled for them ; no one can per- 
form the work of a locomotive engineer without preliminary 
training, and this natural limitation of the number of trained 
locomotive engineers makes it possible for their union to get 
along without maintaining either apprenticeship regulations or 
the policy of the closed shop.^ And it rarely places dependence 
upon the strike. An admirable system of mutual insurance and 

1 The familiar union rule prohibiting members of the union from working with 
non-union men. The policy is very elastic. No objection is made to working with 
members of an occupation not yet organized ; some unions apply the ban only to 
non-union men in the same trade or craft ; while others practically refuse to work 
for an employer who hires any non-union men at all (not applying the term 
"non-union men" to laborers, porters, and other unorganized workers). 



448 OUTLINES OF ECONOMICS 

simple collective bargaining is usually sufi&cient to keep the 
membership loyal and obtain from employers fair rates of pay. 

In the unskilled trades, on the other hand, where a period of 
apprenticeship is wholly superfluous, some more artificial protec- 
tion of the standard of life is employed, like the " policy of 
the closed shop " ; and this naturally forces the union, in turn, to 
place great dependence upon the strike and boycott. Before 
condemning a union for employing some of these policies, there- 
fore, or contrasting it unfavorably with highly conservative 
unions, like the railway brotherhoods, it is necessary to inquire 
whether or not, like the railway brotherhoods, it is protected 
by some natural condition of the business which makes peace- 
able collective bargaining comparatively easy. 

The Problem of the Closed-Shop Policy. — It is impossible 
to pass any general verdict upon the justice of the closed-shop 
policy. Most Americans are inclined to condemn it offhand as 
an attempt to deprive the non-union man of his " sacred right 
to work." They forget that the union man enforces the closed- 
shop policy for an exercise of his " sacred right of quitting work." 
Except where violence is employed, the union which is attempt- 
ing to enforce a closed-shop policy threatens to do nothing worse 
than direct its members to quit the employment of the proprietor 
of the open shop in question. Two equally " sacred and inalien- 
able rights " clash in this contest, and it is plain that no decision 
concerning the legitimacy of the closed-shop policy can be deter- 
mined offhand by applying the touchstone of individual rights. 
If we would know whether a strike against non-union men is jus- 
tifiable or unjustifiable, we must inquire into all the surrounding 
circumstances and the manner in which the strike is conducted. 
If the strike is conducted peaceably, and if the union in question 
is an open union, cordially inviting the " scabs " to enter and 
share its benefits ; if the rate of wages and other conditions of 
employment demanded by the union men are reasonable in view 
of the cost of living and other similar conditions ; if the " scabs " 
involved, by accepting less than a living wage or other harmful 
conditions of employment, are working — even though of neces- 
sity — to undermine the American standard of living ; then we 



LABOR PROBLEMS 449 

have no hesitation in saying that the employment of the closed- 
shop policy on the part of the union is thoroughly justifiable. 
So far as the law is concerned the Supreme Court of the United 
States has decided that an employer — perhaps a large corpora- 
tion — may discharge an employee for belonging to a union, for 
any reason or for no reason ; and a recent act of Congress em- 
powers combinations of workingmen to do in trade disputes 
anything which they might lawfully do as individuals. The 
law — or federal law at least — is apparently impartial. But 
from the standpoint of equity and morals employers frequently 
discharge men for indefensible reasons and unions frequently 
attempt to enforce the closed-shop rule for purposes or by 
methods which deserve to be condemned. 

We must not confine our attention wholly to the injury done 
to the non-union man. The non-union man frequently does a 
real injury to his fellow-workers by accepting wages or other 
conditions of employment that are inconsistent with the Ameri- 
can mode of living. The price cutter in the labor market is not 
ordinarily a social benefactor. The weakest, dullest, and least 
enterprising laborer exerts an influence upon the general level of 
wages out of all proportion to his importance or his deserts. 
If this be true, the man who cuts the standard rate of wages 
may do a grave social injury, and there is justification for those 
who peaceably combine to prevent him from doing his destruc- 
tive work. It must be remembered, however, that these con- 
clusions are based upon the assumption that the union is an open 
union and that the strike is conducted without intimidation or 
interference with the non-union men. The moment the union 
stoops to violence, that moment it loses all claim to the support of 
an enlightened public opinion. 

Limitation of Output. — Another policy which is generally, 
and in many cases unjustly, condemned is the regulation of out- 
put, systematically practiced and indorsed by most unions. 
The output of the worker is limited in many ways. The reduc- 
tion of the hours of labor, the limitation of wages which some 
unions working by the piece system enforce, the prohibition or 
penalization of overtime, all operate to check the activity or 



45° OUTLINES OF ECONOMICS 

reduce the output of the particular workman. Here, again, 
it is unsafe to render any general verdict upon the legitimacy of 
the policy in question. In some industries in which the piece 
system is employed, the rate per piece has unquestionably been 
forced down and the workers spurred to excessive exertion by the 
pressure and influence of pacemakers or taskmasters, paid by 
the employers to urge the workers to the utmost speed. Where 
such conditions prevail, no one can successfully question the 
justice of the feeling which leads the union to object to the 
presence of pacemakers and to prescribe a maximum wage — 
usually above that secured by the average workman — which 
union members are not permitted to exceed. In general, it is 
plain that an individual laborer may underbid a competitor by 
working more intensely, as well as by offering to work longer 
hours or at lower pay. On this account alone, trade unions 
are justified in defining and maintaining some regular. pace or 
standard intensity of work. Without such definition, collective 
bargaining would be impossible. This last observation, it will 
be noted, applies only to trades working by the day. But even 
where the piece system is used, the workers may be justified in 
fixing a liberal limit to the amount of piecework which the wage 
earner shall be permitted to do in a day. For there can be no 
question that unregulated piecework does stimulate the worker 
to excessive exertion, and that as daily earnings under the piece 
system tend to rise, the employer is tempted to reduce the rates. 
Some methods of restriction, however, are wholly vicious. 
The Journeyman Stone Cutters' Union, for instance, stoutly 
resisted for years the application of machinery to their work, and 
actually attempted to prevent the shipment of machine-planed 
stone into any city where the union had succeeded in preventing 
the introduction of planers. Such an attitude toward the intro- 
duction of labor-saving devices deserves the severest condemna- 
tion. Moreover, in some unions there is a tacit approval of the 
" go-easy " system, the system of " soldiering," or " adulterat- 
ing labor," as it has been aptly termed. Such a method of 
restricting output not only corrupts the character of the indi- 
vidual workman who practices it, but makes it impossible for 



LABOR PROBLEMS 45 1 

the employer to deal with the union as a seller of honest goods, 
and in this way tends to undermine the whole foundation of 
trade unionism, which is, as has been said, collective bargaining. 
On the other hand, there is no particular reason to believe that 
union labor is especially given to " go-easy " habits of work. 
The habit of stealthy loafing is found at its worst in certain 
unorganized trades or occupations, so that when it appears 
among union workmen it cannot logically be attributed to 
organization alone. 

Educational and Fraternal Activities. — Practically all unions 
have important educational and social activities. Debate upon 
economic topics is common in union meetings, particularly at the 
conventions of the state and national organizations. It has even 
been said by observers in close contact with the facts that 
foreign-born wage earners receive their most helpful and vital 
education in American public questions through the agency of 
the union. This broad education, which is a most important 
factor in elevating the standard of life, is supplemented by 
the social activities of the labor organization. Many unions 
maintain a so-called " Ladies' Auxiliary," in which the wives 
of the members participate ; give concerts, dances, and other 
social entertainments, maintain charitable activities, and by 
general social intercourse operate to unify and solidify the stand- 
ard of life of the wage-earning group concerned. 

Closely allied with these educational and social features is the 
system of insurance benefits, which has played a very prominent 
part in the development of labor organizations. In Great Britain 
fully three times as much money is expended by the unions 
upon mutual insurance of various kinds as upon administrative 
activities, or for the support and encouragement of strikes. 
Union insurance is helpful, not only in stimulating thrift among 
the individual members, but in making the union more careful 
and conservative in its policies. Moreover, it serves to keep 
in the union a large number of members, who, if they had no 
financial stake in continued membership, would drop out of the 
union in times of peace, when no apparent advantage was to 
be derived from the union. All things considered, the Cigar 



452 OUTLINES OF ECONOMICS 

Makers' International Union has many claims to be considered 
the most successful American labor organization ; and its suc- 
cess is in a large degree, if not in the largest degree, attributable 
to its wise and extensive use of mutual insurance. But on the 
whole, the American unions make relatively little use of the 
insurance benefit. Most of them pay strike benefits, — that is 
part of their fighting policy, — and perhaps a majority of them 
pay funeral benefits, while a respectable majority pay sick 
benefits. But the employment of the superannuation, accident, 
traveling, or " out-of-work " benefit is comparatively rare. The 
great majority of American unions are militant in character, 
existing primarily for the purpose of collective bargaining, and 
placing the greatest reliance upon the policy of the closed shop 
and the strike. 

The Strike. — Probably the most important weapon of the 
trade union is the strike. Unfortunately, also, the weapon is 
far too frequently used. Several generations ago most trade 
unions, while they vehemently defended their right to strike, 
cordially indorsed arbitration and apparently looked upon the 
strike as a weapon of last resort. Today, the average trade 
union is at best only a lukewarm advocate of arbitration, while 
it has come to regard striking as a permanent policy. The net 
result has been to commercialize the strike, as it were. Instead 
of being a more or less spontaneous outburst against conditions 
which the workingman regarded as unrighteous and oppressive, 
the strike has come to be a commonplace method of bettering 
conditions of employment ; a device to be employed when con- 
ditions are favorable, to be laid aside when conditions are 
unfavorable, but to be used without regard to ethical considera- 
tion when its use appears to be profitable. 

The statistics of strikes published in the Twenty-first Anmial Report of the 
(United States) Commissioner of Labor, in the recurrent reports on strikes 
and lockouts of the Massachusetts Bureau of Labor Statistics, and in similar 
reports of other state labor bureaus, indicate that strikes are steadily increas- 
ing in the United States. Moreover, comparison of the number of employees 
thrown out of work with the general wage-earning population indicates, 
although not so certainly, that the proportion of workingmen annually 
involved in strikes has been slowly increasing. Precisely what is responsible 



LABOR PROBLEMS 453 

for this increase in strikes is difi&cult to determine. The change in the 
attitude of labor organizations toward the strike is an important factor, no 
doubt. But the greatest reason for the increase, in all probability, is the 
rapid growth of organized labor. New unions are prone to strike. The 
sudden realization of their new power, and the accumulation of strike funds, 
tempt them to try their wings. In the long run organization probably exerts 
a conservative and steadying influence : national machinery is created which 
curbs the capricious impulses of the local unions; experienced men are 
usually elected to the more important national offices, and when they are 
called in to settle a local grievance, they arrive upon the scene of action 
without personal resentment against the employers involved. These facts 
create a strong hope, and, indeed, a confident belief, among many of those who 
have studied the labor question, that when practically all American trades 
are organized, strikes will steadily decrease, as they have in England, where 
a much larger part of the wage-earning population is organized than in this 
country. 

Labor leaders maintain that strikes strengthen the sohdarity of 
the unions, and encourage the members to make personal sacri- 
fices for the common good, while they force employers to respect 
the strength of organized labor, and are not, in the long run, par- 
ticularly costly. The time lost in strikes, they say, largely takes 
the place of enforced vacations — seasonal stoppages, and other 
kinds of unemployment with which the average wage earner is 
normally visited during the course of the year's work. No 
amount of such dialectic, however, can argue out of existence the 
injury and destruction resulting from strikes. Many strikes are 
gravely injurious to the wage earners themselves ; and almost 
all strikes injure employers and the consuming public. From 
the social standpoint the strike is an evil, and all justifiable 
means should be employed to prevent its occurrence. 

We must not conclude, however, that workingmen and labor 
organizations are wholly responsible for strikes. If a body of 
men agree not to work for a given employer unless that employer 
complies with certain conditions, whose fault is it if the employer 
refuses to comply and a strike follows? Very evidently the 
fault may lie with either the master or the men, or with both. 
The fault lies with the men if the conditions which they demand 
are, in view of all the circumstances, unreasonable and extortion- 
ate. The fault lies with the employer if he refuses to grant 



454 OUTLINES OF ECONOMICS 

reasonable conditions of employment. Sometimes the fault is 
with one, sometimes with the other ; sometimes the one gains 
by the strike, sometimes the other; but the public, which is 
never at fault, stands always to lose. The greatest lesson to 
be derived from a consideration of strikes is the necessity of their 
suppression in the interest of the general public. 

One of the greatest evils attendant upon the strike is violence emanating 
from both sides, — from employers' associations as well as from labor unions. 
It is frequently said that this is diminishing with the passage of years. The 
statement is both true and untrue. A study of labor disputes in the early 
period of the modern labor movement seems to show that the average strike 
of that period was attended with much more violence than the average strike 
of today. Most labor leaders have thoroughly learned the lesson that 
violence does not pay, and they exert every effort to suppress it. But- at the 
same time the average strike of the present time is attended with some 
violence or coercion, and the steady increase in the number of strikes makes 
the aggregate amount of violence now greater than it was in the past. 

Historically, also, a marked change has shown itself in the character of 
the violence employed. In the past, labor lawlessness was more or less 
sporadic; brutal, it is true, but frank and unpremeditated. The lawless- 
ness of today, however, has taken on a far more sinister form ; it has become 
deliberate, premeditated, in many cases official. The outrages perpetrated 
by the officers of the International Union of Bridge and Structural Iron- 
workers (the "dynamite conspiracy") and the whole labor history of the 
mining industry in Colorado and Idaho make it plain that there has been a 
certain amount of carefully planned violence perpetrated with the passive 
consent, if not with the active encouragement, of union officials and members. 
There can be no doubt, also, that individual employers and employers' 
associations have stooped to equally reprehensible practices. They have 
employed as watchmen or detectives ex-convicts, thugs, and professional 
bad men, who unquestionably have not refrained at times from perpetrating 
violence in order to cast discredit upon the unions. It is impossible to con- 
clude which side is the more to blame. The lesson to be drawn is the pubUc 
necessity of suppressing and punishing violence or intimidation when prac- 
ticed by either side of the controversy. 

Employers' Associations. — The development of modern em- 
ployers' associations has been briefly described in an earlier 
chapter. Their activities give rise to a movement which may 
be briefly described as an anti-labor movement. They are, in 
almost every respect, the natural foil and counterpoise of the 
labor organization. They resemble the association of laborers 



LABOR PROBLEMS 455 

even in structure. Thus we have had employers' associations 
recruited entirely from one industry, such as the Stove Founders' 
National Defense Association ; associations of employers in 
distinct but related industries, such as the national Metal Trade 
Association ; and mixed associations in which all kinds of em- 
ployers are united, such as the Citizens' Alliances, so common 
a few years ago in many of the Western cities. To complete the 
analogy, these associations frequently combined in city, state, 
and national federations ; thus forming large confederacies, 
similar in scope and activity to the state and national federation 
of labor. Speaking generally, employers' associations show less 
permanence than trade unions and many of the employers' 
associations which were active a decade ago are now moribund. 

We find the same resemblances between employers' associa- 
tions and labor organizations when we examine the policies and 
aims of the former. Thus they make frequent use of the lock- 
out. The Stove Founders' National Defense Association, for 
example, began its interesting career with a lockout of the iron 
molders in the employ of its members. Like the trade unions, 
also, they have their legislative committees or lobbies, and are 
credited, for instance, with having played an important part 
in defeating the eight-hour and anti-injunction bills which 
have been before Congress several times. Some of these or- 
ganizations also maintain so-called labor bureaus, whose func- 
tion it is to secure accurate information of the workmen in the 
trade, so that troublesome agitators may be refused employment ; 
and the methods employed in this branch of the work give rise 
to something closely akin to the " unfair list " published by 
many national unions. Some of the more radical associations 
have stooped at times to violence and coercion, as was illustrated 
in 1904 by the employers' associations of the Cripple Creek 
district which boycotted business firms, forced public officials 
to resign by threats or violence, and filled the vacant places with 
their own adherents. 

Some of the employers' associations are conservative in tone 
and policy, working harmoniously with the labor organizations 
in the industry, and going no farther than to endeavor by every 



456 OUTLINES OF ECONOMICS 

legitimate measure to further the interest of the affiliated em- 
ployers. Such associations are exceedingly helpful in furthering 
that regime of peaceable collective bargaining to which most 
students of this subject look forward as the ultimate outcome 
of present-day tendencies. They are thus doing in an effective 
way the work of industrial peace. Another group, however, 
while temperate in tone and waging no warfare on the labor 
organization as such, nevertheless maintain certain fundamental 
principles which are directly in conflict with the fundamental 
tenets of trade unionism. These associations, for instance, 
maintain that the method of wage payment — i.e. whether 
wages shall be reckoned by the hour, the piece, or the premium 
system — is a matter which concerns the employer alone, and 
they refuse to submit such questions to collective bargaining or 
arbitration. Associations in this second group do not needlessly 
foment strifes with the unions, but they regard industrial peace 
as a consideration secondary to the maintenance of their funda- 
mental principles, and accordingly they have been involved in a 
number of protracted strikes and disputes. Finally, there is a 
third group of employers' associations, of which the average citi- 
zens' alliance is a good example, which may be correctly described 
as " union smashers." Such associations have little regard for 
the establishment of sound principles of collective bargaining, 
and they are usually violently opposed to any recognition of 
organized labor ; their aim is to weaken and harass their enemy, 
the labor organization, whenever possible. They represent 
among employers something of the same feeling and attitude 
which characterize the Industrial Workers of the World (a syn- 
dicalist organization opposed to trade agreements, trade union- 
ism, and even to socialism ; placing its reliance upon the strike, 
direct action, and sabotage). The extremely radical organiza- 
tions on both sides secure, by reason of their revolutionary ut- 
terances and tactics, far more attention than their intrinsic 
importance justifies. 

Owing to this difference of policy among the various employers' 
associations, it is difficult to predict how the anti-labor move- 
ment will affect that question in which the public interest is 



LABOR PROBLEMS , 457 

greatest — the question of industrial peace. For some little 
time, perhaps, the militant enthusiasm of the more belligerent 
associations will probably result in multiplying strikes and 
lockouts. In the end, however, they will probably contribute 
effectively to the maintenance of industrial peace by checking 
the more extortionate demands of the unions and by securing 
that degree of organization among employers which is necessary 
for the successful operation of collective bargaining. If wage 
earners are to act in concert by common or standard rules, it is 
evident that eventually they will have to deal with an organized 
body of employers ; and the sooner such organization of em- 
ployers is perfected, the sooner will collective bargaining be 
established as the regular method of determining conditions of 
employment. 

The Agencies of Industrial Peace. — Although collective bar- 
gaining does not necessarily and in every instance operate to 
discourage strikes, its net influence is unquestionably favorable 
to the maintenance of industrial peace. Where a powerful trade 
union exists, and the employers resolutely refuse to deal with it, 
strikes are frequent. Where the opposite policy is pursued, and 
the employers frankly recognize the union, strikes are infrequent. 
In the bituminous mining industry of the East, among steam 
railway employees -in the train service, in the needle trades of 
New York, and in many of the industries of England, strong 
organizations of employers and employees have shown through 
collective bargaining the power to maintain industrial peace for 
long periods of time. 

Trade Arbitration. — In England, many, if not most, of the 
wider systems of collective bargaining are based upon formal 
treaties, which provide for arbitration in case the two parties 
cannot come to an agreement concerning terms. This is fre- 
quently referred to as trade arbitration. But in the United States 
many of the general conferences are based upon agreements 
which do not provide for arbitration at all. Peace is main- 
tained, although neither side promises in any way to refrain 
from strikes or lockouts. Mutual respect and free discussion 
prevent actual warfare. Indeed, many authorities upon this 



458 OUTLINES OF ECONOMICS 

subject are inclined to think that the introduction of arbitration, 
even as a last resort, weakens the efficiency of collective bargain- 
ing. It is almost always necessary for both sides in collective 
bargaining to make some compromises ; and this necessity 
imposes upon the representatives of the trade unions the dis- 
agreeable duty of reporting to their constituents that they have 
not secured the exact terms which they were instructed in the 
beginning to demand. Because of this fact, if a provision for 
arbitration exists, the union representatives are disposed to throw 
the responsibility of disappointing their followers upon the 
shoulders of the arbitrators. 

Moreover, collective bargaining is essentially inconsistent 
with arbitration. Collective bargaining is commercial and 
elastic ; it deals with the formulation of future terms of employ- 
ment; it looks to securing the best results possible; it has no 
rational foundation save the willingness of the parties concerned 
to get the most possible for their labor or their money, as the 
case may be ; whereas arbitration is judicial in essence, and its 
successful application implies the acceptance of some established 
principle of wage adjustment, in the justice of which both parties 
acquiesce. It is unfortunate but true that up to the present 
time no one has ever formulated a doctrine of wage adjustment 
which is at once workable and acceptable to a majority of the 
people. Arbitration is a perfectly logical device, and works 
successfully in the interpretation of minor difficulties growing 
out of a broad agreement which has already been accepted. 
Or, if both sides adopt some governing principle, it is perfectly 
possible for a disinterested arbitrator to decide what this principle 
demands in a given situation. But as a helpful device in securing 
the initial adoption of a fundamental agreement, mediation is 
superior to trade arbitration, although the latter appeals to the 
employers because it promises to prevent stoppage of work 
pending the decision of disputes. 

Voluntary Arbitration. — There are, of course, many other 
kinds of arbitration which have proved helpful in maintaining 
the industrial peace. Most advanced states now maintain 
boards of conciliation and arbitration, whose business it is to 



LABOR PROBLEMS 4^9 

prevent strikes if possible, and to adjust or settle them after 
they occur. For the most part, these voluntary boards of con- 
ciliation and arbitration have shown little ability to cope with the 
real situation. Much' more, however, could be made of voluntary 
conciliation and arbitration than has been made in the past. 
The short but very promising history of the Canadian Industrial 
Disputes Investigation Act of 1907 suggests that a law which, 
like the Canadian Act, forbade strikes and lockouts in important 
industries until an impartial board of conciliators had had time 
to investigate the dispute and publish their recommendations 
and findings concerning the equities of the case, would go 
far toward delivering us from the more injurious industrial 
conflicts. The vital provisions of such a method of concilia- 
tion are : (i) the prohibition of strikes and lockouts before 
and during the investigation; (2) widespread publication of 
the findings of the board of investigation and conciliation ; and 
(3) full permission to strike or lockout after the publication of 
the findings. 

Compulsory Arbitration. — In New Zealand an even more 
radical remedy — " compulsory arbitration " — has been tried. 
Seven workingmen in any industry may organize a union and 
lodge a demand for better conditions of employment before 
arbitration boards, whose decisions, when ratified by the supreme 
or central court of arbitration, are absolute and binding. Simi- 
larly, any employer whose workmen are organized in a union may 
take a case to the arbitration tribunals for settlement. An 
award of the central court of arbitration may be extended by 
the court to all competitors of the original employer in the colony. 
In this way, compulsory arbitration brings about the intro- 
duction of minimum wages and other conditions of employment, 
established by the authority of the state and enforced^ not only 
by the watchful eyes of the parties concerned, but by the factory 
inspectors themselves. In Victoria and South Australia much 
the same results are reached through the agency of wage boards 
— containing representatives of both the employers and their 
employees, with a chairman selected by these representatives 
or appointed by the government — which are empowered to pre- 



\( 



460 OUTLINES OF ECONOMICS 

scribe minimum wages and other conditions of employment, that 
are enforced, as in New Zealand, by the factory inspectors. 
Strikes, however, are not prohibited under this system, although 
they are very rare in industries in which wage boards regulate" 
wages and hours of labor. 

It is impossible to enter into a detailed discussion of either the 
New Zealand or the Victoria system at this place. Both systems 
have been in operation since 1896, both have been extended to 
other Australian colonies. The laws recently adopted in New 
South Wales, South Australia, and Queensland contain the 
principal features of both systems. The fixing of minimum 
conditions of employment is perhaps the most important element 
in both systems, but it is noteworthy that the compulsory 
arbitration idea has endured and spread. Strikes are not wholly 
prevented, particularly in industries in which the labor organiza- 
tions are very strong ; and many employers criticize both systems 
vehemently. With the passage of time, however, they have 
been strengthened, not repealed ; and the consensus of qualified 
opinion seems to be that they have succeeded. But there is 
little probability that general compulsory arbitration will be 
introduced into this country in the near future. It would in all 
probability be held to conflict with state and. federal constitu- 
tions, and, moreover, a large majority of trade unionists are 
opposed to it. 

The Ultimate Solution. — In arriving at a decision concerning 
the measures which ought to be taken to maintain industrial 
peace, it should be remembered that strikes are much more 
destructive and dangerous in some industries than in others, and 
that here, as in most other economic problems, it is dangerous to 
proceed wholly on the basis of general principles. In most 
industries, in our opinion, the strike question may safely be left 
to the enlightened self-interest of the parties concerned, trusting 
to collective bargaining and the work of voluntary arbitration to 
prevent an excessive amount of war. In small competitive 
industries the peaceful strike is not necessarily an alarming 
phenomenon. 

Slowly and surely, however, the opinion is gathering force that 



LABOR PROBLEMS 46 1 

in those industries which vitally touch the public welfare (such as 
the anthracite coal industry, railway transportation, and the like) 
the public should, and by an exercise of legal ingenuity might, find 
means to preserve the peace whether the two parties immediately 
concerned desire peace or not. Compulsory arbitration in com- 
petitive industries would unquestionably be unconstitutional in 
this country. But with quasi-public industries, " industries 
affected by a public interest," the question is entirely different. 
If, because of their monopolistic character and their intimate 
connection with the convenience of the public, the legislature 
may regulate the service and the rates of such industries, it 
would seem to follow even more clearly that the legislature may 
adopt any measure necessary to prevent the utter cessation of 
such industries by strikes and lockouts. If, for instance, the 
fare charged by a street railway may be regulated by the state, 
in order to prevent monopolistic extortion, how much more 
justifiable would be the action of the state in preventing the 
complete interruption of the traffic of the railway by means of a 
strike ' or lockout ! The federal government in the Erdman 
and Newlands Acts provides machinery for mediation and 
arbitration in disputes affecting interstate railways. Many 
important disputes which threatened widely to interrupt inter- 
state commerce have been settled by mediation — and a few 
very important disputes by arbitration — under these laws. 
Many threatened strikes by employees in the train service have 
been prevented ; and it is interesting to . observe that with the 
passage of time more use is made of arbitration, and that under 
certain circumstances the arbitrators are permitted to make 
binding awards. Compulsory arbitration or public regulation 
of wages in the railway and other industries affected with a 
public use is, we believe, an inevitable concomitant of the 
public regulation of prices and profits in these fields. 

Profit Sharing. — Profit sharing attempts, not to provide a 
remedy for industrial disputes, but to anticipate and prevent 
them by assigning to the employees a share of the profits fixed 
in advance. It is held that this arrangement enlists the em- 
ployees' interest in the success of the business, makes them more 



462 OUTLINES OF ECONOMICS 

economical, and so increases their zeal and efficiency that the 
share of profits which they receive does not reduce in the long 
run the earnings of the employer. In other words, the em- 
ployees create the fund from which their bonus is paid. This 
bonus may be paid in many different ways : either in cash at the 
end of the business year, or in shares of stock in the company in 
question, thus making the workman partial owner of the busi- 
ness ; or it may be amassed in a savings or insurance fund, from 
which in his old age the workman receives a pension, or his 
family an annuity or cash premium at the time of his death. The 
last method of profit sharing is usually spoken of as '' deferred 
participation." 

Neither historical study nor theoretical analysis of profit shar- 
ing furnishes reasonable ground for the belief that this method of 
industrial remuneration will ever play an important part in 
solving the modern labor problem. Informal profit sharing is 
probably very old ; and the principle or theory was recognized 
by the French economist and statesman, Turgot, as early as 
1775. In 1842 the celebrated French firm of Leclaire* inau- 
gurated a system of profit sharing which has been permanently 
successful. In the third quarter of the nineteenth century 
profit sharing was widely discussed. In 1878 a hundred and 
twenty instances were known, and the number grew steadily 
until about 1896, since which time the relative importance of 
profit sharing as a method of industrial remuneration seems to 
have decHned, notwithstanding the wide publicity which has 
been given to the profit-sharing plans of the United States Steel 
Corporation and the Ford Motor Company. 

The reasons why profit sharing has not proved more successful 
are various. In the first place, it has incurred the enmity of 
most labor leaders, who oppose it because it has often been 
introduced after a disastrous strike as an antidote to trade 
unionism, and because they believe that it stimulates the men 
to work beyond their strength, and eventually results — as 
overspeeding always results — in reduced wages. 

In the second place, it is illogical and inconsistent as explained 
by most of its advocates. The latter assert that the workmen 



LABOR PROBLEMS 463 

create the fund from which their dividends are paid by increased 
care, zeal, and speed. If this be true, and the system can hardly 
prove a permanent success unless it is true, the end which profit 
sharing seeks would be better achieved by the piece rate or gain 
sharing methods of wage payment. By both of these methods 
the worker gets his premium for extra zeal and efficiency as part 
of his wage, not as a gift ; gets it on pay day, not at the end of the 
year ; and feels as free to bargain and higgle about the size of the 
premium as he does about the size of the wage. Moreover, his 
premium cannot be dissipated by unwise management or dishon- 
esty on the part of the employer, and it cannot be lost by reason 
of his death, discharge, or change of employment. 

Profit sharing is too often applied in an unbusinesslike way 
that smacks of philanthropy. The average employer con- 
sciously or unconsciously expects something in return for the 
dividends which he distributes. And if he does expect a return, 
it is far better that he should pay for it by a method which is 
certain, fixed by contract or bargain in advance, and paid, not at 
long intervals, during which it is threatened by the varying 
fortunes of the business, but at the end of the week or month 
when ordinary wages are paid. Of course, if in addition to fair 
wages the employer wishes to distribute a gratuitous dividend 
at the end of the year, for which he expects nothing in return, the 
employee is not likely to object, and the generosity of the em- 
ployer will probably do no harm. But such a system of profit 
sharing cannot be expected to become prevalent throughout a 
competitive commercial system in which most employers cannot 
be philanthropists, even if they desire. Moreover, human na- 
ture is so constituted that gifts of this kind create in the mind 
of the giver an inevitable expectation of recompense. 

Industrial Democracy. — The industrial organization of the 
past was despotic. The despotic principle, the one-man power, 
is an excellent thing in its own time and place. It gives to indus- 
try the elasticity, celerity, and general efiiciency which come 
from singleness of aim ; and in industry, despotism has con- 
tinued longer than in the poUtical sphere. But it is merely a 
phase of development and cannot be regarded as final. Else- 



464 OUTLINES OF ECONOMICS 

where the despotic principle has been softened or limited, — in 
politics, in religion, in the family, — • and eventually this dis- 
cordant element is bound to disappear or undergo serious modi- 
fication in industry. The labor movement is primarily a 
concerted effort to Sichieve industrial democracy, which means self- 
rule, self-control, the self-direction of the masses in their efforts 
to gain a livelihood. It is principally because profit sharing 
means a departure from, and not an approach toward, industrial 
democracy that it has made so little progress, comparatively 
speaking, in the last fifty years. A far more consistent method 
of securing self-government is found in cooperation. 

Cooperation is of two kinds, coercive and voluntary. Coer- 
cive cooperation, which implies a partial or complete application 
of socialism, is discussed in another chapter. 

Voluntary cooperation takes many different forms, among 
which we may distinguish : (i) distributive or consumers' coop- 
eration, sometimes spoken of as cooperative buying ; (2) coopera- 
tive borrowing or cooperative credit ; (3) cooperative marketing ; 
and (4) producers' or pure cooperation. 

Consumers' or distributive cooperation has no necessary con- 
nection with the transportation of goods, but refers merely to a 
method of retail or wholesale exchange. Purchasers of groceries, 
dry goods, and the like come together to purchase what they 
need, and thus eliminate profits. They form a stock company, 
subscribe for shares, employ a manager and clerks, — who often 
do not even share in the profits, — and start a business. Divi- 
dends are sometimes paid only on shares, but the approved way 
is to pay a moderate interest on the investment and to divide 
profits among the customers in proportion to purchases, the divi- 
sion being made at the end of stated intervals. Usually a larger 
dividend is distributed to shareholders than to ordinary cus- 
tomers ; and in some cases the employees receive as large a bonus 
as the shareholders. Profits are thus said to be divided among 
capital, custom, and labor. But so far as labor is concerned, the 
most that can be said is that it receives a small share of the 
earnings ; labor does not cooperate in the sense that it has an 
important voice in the management of the business. The scheme 



LABOR PROBLEMS 465 

is one of distributive cooperation plus profit sharing, not one of 
pure cooperation. 

Cooperative credit and cooperative marketing are familiar 
phenomena in the United States: the first in the form of the 
well-known building and loan association; the second in the 
form of fruit growers' associations, cooperative elevator com- 
panies, and the like, formed for the purpose of securing better 
terms and facilities from railroads, commission houses, and 
middlemen in general. In 191 2, for instance, there were 6300 
building and loan associations in the United States, with a 
membership of 2,500,000 and total assets of $1,138,000,000. 
At the same time there were many cooperative telephone com- 
panies, particularly in small towns and rural districts. 

The good which these cooperative associations have accom- 
plished is enormous, and there can be no doubt of their practi- 
cability. They have not only proved commercially profitable to 
the participators, but they have trained them to " team work " 
and inculcated the spirit of mutual concession, the give and take 
of concerted endeavor, which makes for social solidarity and con- 
stitutes such an indispensable element of good citizenship in a 
democratic state. 

But they have done little and promise to do little in solving 
the labor problem or in essentially improving the distribution of 
wealth. They are, for the most part, composed of small capital- 
ists, farmers, or salaried men (not wage earners), and in organiza- 
tion differ little from democratically managed stock companies 
of the usual type. Many, if not most, of the marketing associa- 
tions are profit-making concerns whose employees have no more 
voice in the selection of their bosses, and no more share in the 
management of the business, than the employees of an ordinary 
corporation. Even in the British cooperative societies the 
employees have no share in the management, and though some of 
the associations — notably the Scottish Wholesale Society — 
indulge in a mild species of profit sharing with their employees, 
the result is not industrial democracy, not self-government, but 
merely joint buying plus a paternalistic scheme of profit sharing. 
The limits of the success of the British cooperative movement 

3U 



466 OUTLINES OF ECONOMICS 

are suggested by the fact that the employees of the cooperative 
societies have formed themselves into a trade union for the 
betterment of their condition of employment.^ 

While consumers' cooperation and cooperative marketing — 
both designed to abolish the profits of the middleman — are 
important and praiseworthy forms of economic association, they 
have little effect upon the wage-earning classes, and offer no 
remedy for the antagonism between capital and labor in manu- 
facturing industries. The variety of cooperation which really 
copes with these questions and seriously attempts to regenerate 
the wage system is producers'' cooperation. The essential fea- 
tures of this form of cooperation are (i) that each group of 
workers is to be associated by their own free choice ; (2) that 
these associates shall work under a leader elected and removable 
by themselves ; and (3) that the collective remuneration of the 
labor performed by the group shall be divided among all its 
members (including the leader) in such a manner as shall be 
arranged, upon principles recognized as equitable by the society 
themselves. 2 

Successful cooperative experiments fulfilling the above con- 
ditions are seldom met with. But they are not unknown. Here 
and there a man of transcendent commercial genius and extraor- 
dinary sympathy has succeeded in democratizing his business, 
turning it over to his employees, and so impressing his spirit and 
his methods upon his successors that the business continues to 
prosper under the regime of self-government. An illustration 
is found in the Godin Familistere of Guise, France, which, begin- 
ning with a scheme of profit sharing in 1877, has finally resulted 
in the establishment not only of a cooperative manufacturing 
enterprise, but in the successful conduct of what practically 
amounts to a cooperative community. 

But such cases are rare. Most experiments in producers' co- 
operation have failed, and we fear they must continue to fail. 
They apparently cannot meet the competition of businesses 

1 For an account of some of the advantages of certain types of cooperative 
marketing, see Chap, xxix {A gricuUural Problems) . 

*D. F. Schloss, Methods of Industrial Remuneration, p. 228. 



LABOR PROBLEMS 467 

organized in the ordinary way, directed by one man or set of men 
with all the efficiency, mobility, and adaptability that come from 
singleness of aim and undivided management. Industrial 
democracy, as achieved in the cooperative form of industrial 
organization, is too unwieldy, too slow, too mechanical. Multi- 
tudinous management means relatively uncertain, indecisive, and 
inefficient management. 

A modified form of producers' cooperation is not unknown among the 
manufacturing industries of this country. An approximate idea of the 
extent of this form of industrial organization may be gathered from recent 
census statistics. In 1909 the statistics of manufactures relating to char- 
acter of ownership show a separate class of "miscellaneous business organiza- 
tions" which consists almost entirely of cooperative manufacturing concerns. 
There were in this group 4120 establishments (constituting 1.5 per cent of 
all manufacturing establishments) employing 12,934 persons (0.2 per cent 
of all wage earners), producing goods with an annual value of $104,766,104 
(0.5 per cent of the aggregate product). Most of these associations are 
cooperative creameries; and it is interesting to note that in this great 
industry — which was cooperative in origin — the corporate form of organ- 
ization increases in importance, measured by value of products, more rapidly 
than the cooperative form. These figures furnish a maximum estimate of 
producers' cooperation in the United States, and a large majority of the 
concerns credited to cooperation in this enumeration would fail to satisfy 
a strict definition of producers' cooperation. 

The wage contract, whatever its defects, has one striking virtue 
— certainty. The wage earner knows what to expect and gets 
what he expects. He is safeguarded in large measure against 
business risk, and although he may pay too high a price for his 
safety, the safety itself is a highly desirable thing. It is one of 
the weaknesses of producers' cooperation that the workman is 
encouraged to invest his savings in the hazardous competitive 
experiments in which he is engaged. He becomes part owner 
of the enterprise, to be sure, but by doing so he assumes the risk 
of failure, a risk which, other things being equal, it is desirable 
to eliminate. It is very likely that the ultimate method by 
which industrial democracy is achieved will retain that feature 
of the present wage system by which most of the workers are 
largely safeguarded against business losses. 



468 OUTLINES OF ECONOMICS 

The Future of the Union. — If industrial democracy is to be 
achieved, all present indications are that it will be through the 
labor organization. Since the introduction of collective bar- 
gaining, its range has constantly widened. Beginning with 
questions of wages, hours of labor, and apprenticeship, it has 
gradually spread, until at the present time some unions bargain 
about the sanitary conditions of the work, the introduction of 
safety devices, the employment of women, the use of machinery, 
and the status of the men with whom their members work. A 
few powerful unions insist that the foremen under whom their 
members work shall belong to the union, demand a voice in the 
discharge of employees, and try to force the employer, when 
taking on new men, to select them in order from lists of unem- 
ployed journeymen prepared by the union. These demands, of 
course, may be harmful : in industry as in government, certain 
functions must be entrusted almost wholly to the executive head. 
The fact that power may be abused, however, is really beside 
the point. The point lies in the possibility of extending the 
range of collective bargaining until the employees shall have a 
voice — and it is to be hoped a prevailing voice — in determining 
the conditions of employment. Through collective bargaining 
the control of the employees over the business may be indefi- 
nitely expanded. Once having secured control, the majority 
may learn, as they are slowly learning in political life, to leave 
certain particularly difficult questions to their industrial cap- 
tains. In the past, labor has had to seek capital and serve it. 
In the future, capital may have to seek and serve labor. 

These words are written in no spirit of advocacy, and with no 
intention of palliating the obvious shortcomings of the trade 
union. But the fact remains — whether we like it or not — that 
economic theory and economic history unite in the conclusion 
that the union has come to stay as long as the system of capi- 
talistic production. The union must be improved, it cannot be 
extirpated ; and the most urgent task of the present is to con- 
vince employers and unionists that there will be no real peace 
until employers acknowledge the inevitableness of the union, 
and unions acknowledge — sympathetically and in practical 



LABOR PROBLEMS 469 

ways — the social serviceableness of the employer. Trade 
unions have been guilty of many sins — violence, monopoly, 
political corruption. But their gravest danger at the present 
time is a false philosophy, in accordance with which many 
unionists have come to believe that the best way to help the 
union is to oppose the employer. This is not true of the more 
wisely conducted unions. The railway brotherhoods frequently '. 
unite with the railway managers in securing legislation favorable 
to the railway industry ; and the history of the National Civic 
Federation, for example, proves that a number of the opposing 
leaders are keenly aware that capital and labor have interests 
in common as well as in opposition. In some way, however, 
united labor as a whole must learn how to drive just as favorable 
a bargain as possible with the employers in the first instance, and 
then, the bargain having been made, to bend every effort in loyal 
cooperation with the employer to make the business the greatest , 
possible success. This is not mere platitude. In the long run, / 
the institution that stands in the way of productive efficiency | 
will perish. The trade union must bring into industry something \ 
besides conflict, or it will disappear. The union that so con- * 
ducts itself as to make the non-union man or the non-union shop 
more efficient than the union man or the union shop, simply puts 
a premium upon the suppression of unionism. 



QUESTIONS 

1. Is the industrial or the trade union the more logical form of organiza- 
tion ? Can the two be reconciled ? Mention as many kinds of jurisdiction 
disputes as you can. 

2. Does the trade union rest upon a soimd economic basis ? Is it likely 
to endure? Is it in any large degree responsible for the conflict between 
labor and capital ? 

3. Are all attempts to achieve a monopoly illegitimate? Is there more 
justification for labor monopolies than industrial monopolies? 

4. Is the poKcy of the closed shop ever justifiable? Intimidation of 
non-imion men? restriction of apprenticeship ? regulation of output ? 

5. The strike has been defined as a "concerted cessation of work"; is 
this definition correct? Have men a "right" to strike whenever they wish? 
Are employers justified in "locking out" their men at pleasure? 



47o OUTLINES OF ECONOMICS 

6. Is the "blacklist" more justifiable than the boycott? Can either the 
"blacklist" or the boycott be conducted in a lawful manner? 

7. Distinguish between trade arbitration, voluntary arbitration, com- 
pulsory investigation, and compulsory arbitration. What are the defects 
of arbitration as a method of setthng labor disputes? 

8. What is the difference between the Victorian (wage-board) and the 
New Zealand (compulsory arbitration) systems? 

9. Why do labor leaders oppose compulsory arbitration ? Is their op- 
position a sufficient reason for rejecting it ? Why is the plea for compulsory 
arbitration particularly strong in the case of monopolistic industries? 

ID. How does "gain sharing" differ from "profit sharing"? Is profit 
sharing necessarily paternalistic ? If so, is this a defect ? 

II. Does consumers' cooperation materially advance industrial democ- 
racy ? Is producers' cooperation likely to grow and expand ? 



REFERENCES 

Adams, T. S., and Sumner, H. L. Labor Problems. 

Brooks, J. G. The Social Unrest. 

Carlton, F. T. The History and Problems of Organized Labor. 

Cole, G. D. H. The World of Labor. 

Commons, J. R. Trade Unionism and Labor Problems and Labor and 

A dministration . 
Commons, J. R. (Editor). Documentary History of American Industrial 

Society (10 vols.). 
Ely, R. T. The Labor Movement in America. 

Oilman, N. P. Methods of Iiidustrial Peace; A Dividend to Labor. 
Hollander, J. H. and Barnett, G. E. (editors). Studies in American Trade 

Unionism. 
Industrial Commission. Report, Vols, xvii, xix. 
Laidler, H. W. Boycotts and the Labor Struggle. 
Le Rossignol, J. E., and Stewart, W. D. State Socialism in New Zealand, 

Chaps, xiii, xiv. 
Levasseur, E. The American Workman. 
Marot, Helen. American Labor Unions. 
Mitchell, John. Organized Labor. 
PiGOU, A. C. Principles and Methods of Industrial Peace. 
Rowntree, B. S. Poverty: A Study of Town Life. 
ScHLOSS, D. F. Methods of Industrial Remuneration. 
Webb, Catherine. Industrial Cooperation. 
Webb, Sidney and Beatrice. History of Trade Unionism; Industrial 

Democracy. 



CHAPTER XXIII 

LABOR LEGISLATION 

The conditions of employment may be fixed by individual 
bargaining between the employer and employee, by collective 
bargaining between the employer and groups of employees, or 
by the State itself through legislative enactment. The last 
method has in recent years been used not only with increasing 
frequency, but for a variety of purposes which it is desirable to 
differentiate. In the beginning of the nineteenth century, for 
instance, combinations of workmen to improve their conditions 
of employment were unlawful. There was obvious necessity 
for labor laws, therefore, to legalize combination and make col- 
lective bargaining legitimate. But certain classes, particularly 
women and child wage workers, have found it nearly impossible 
to organize for collective bargaining. In their case the state 
has entered upon a program of positive protection, acting so 
far as children are concerned in loco parentis. Adult men, with 
their trade unions, have been left very largely to take care of 
themselves; but trade unions, occupied with the absorbing 
questions of wages and hours of labor, frequently show marked 
indifference towards certain conditions of employment, such 
as safety and sanitation, which from the public standpoint 
are highly important. Of these conditions the public in its 
own interest has been forced to take cognizance. Finally, 
legislative enactments have been used both to foster thrift, 
thus placing the workman in a better position to protect his 
own interests, and to maintain uniform conditions of employ- 
ment, so that industry shall be conducted under uniform rules. 
To most employers, for instance, it makes very little difference 
whether they are permitted to hire children under fourteen 

471 



472 OUTLINES OF ECONOMICS 

years of age or not ; but it is very important to them that they 
should not be bound by more onerous restrictions than are 
imposed upon their competitors. From this and some other 
standpoints, the universaHty and rigidity of the labor law are 
virtues : the stricter its enforcement and the wider the area of 
competition to which it applies, the better. 

Freedom of Contract, Conspiracy, and Injunctions. — In 
the early part of the nineteenth century, peaceable combina- 
tions of workmen to better the conditions of employment were 
illegal both in England and the United States. Before the 
middle of the nineteenth century, however, our higher courts 
had established the doctrine that workingmen might peaceably 
combine to secure higher wages, reduce hours, or improve shop 
and other conditions of employment immediately affecting 
themselves. The trade union acquired a lawful status. But 
it must not be supposed that in the United States this freedom 
was or is complete. Workmen might combine to secure higher 
wages, and might enforce their demands by striking, but in 
most jurisdictions they could not lawfully combine to secure 
the discharge of a non-union man, nor could they threaten in 
concert to quit dealings with a merchant unless he should refuse 
to buy goods from some manufacturer against whom these 
workmen or their friends were striking. Moreover, the move- 
ment towards complete freedom was blocked or delayed in the 
last quarter of the nineteenth century by the widespread adop- 
tion of anti-trust laws, prohibiting combinations in restraint 
of trade. Many of the customary activities of trade unions, 
such as strikes to enforce the closed-shop rule, publication of 
" unfair lists," and the like, are regarded in some jurisdictions 
as restraints of trade. The anti-trust laws thus threw a cloud 
upon the whole trade union movement. Finally the whole 
situation was complicated and embittered by a doubtful use of 
the injunction and by the uncertainty of the law itself. Statutes 
differ, and the interpretations of similar statutes by different 
courts are in hopeless conflict. This confusion constitutes in 
itself a grave social problem. 

We have already recorded the simple solution of this problem 



LABOR LEGISLATION 473 

reached in England : ^ in labor disputes workmen or employers 
may lawfully do in combination whatever any employee or 
employer may lawfully do alone. In this country several 
state legislatures and Congress (so far as federal law is concerned) 
have attempted to enact the same general principles into law; 
but the Massachusetts law on this subject has been declared 
unconstitutional by the Supreme Court of that state, and in 
the opinion of many authorities the federal law is likely to meet 
a similar fate. The Massachusetts decision rests on the general 
argument that the right to work is property, that state and 
federal constitutions prevent any person from being deprived 
of property without compensation or due process of law, that 
combinations of workmen are frequently used to prevent per- 
sons from obtaining work, and that no such combination can 
be legitimatized by mere statute law. Whether the federal law 
on the subject — which is contained in the Clayton Anti-trust 
Act — will be similarly emasculated, it is impossible to say ; 
but as this law is regarded by many labor leaders as the Magna 
Charta of the American labor movement, and as its provisions 
relating to the injunction, at least, are likely to be sanctioned by 
the courts, so much of the act as relates to labor combina- 
tions and injunctions has been briefly summarized below. Each 
provision of the law, it may be noted, records a legislative 
verdict upon some hotly contested point ; and interpreted in 
this light the Clayton Act becomes a valuable historical sum- 
mary as well as a statement of the present federal law. 

"The labor of a human being is not a commodity or article of commerce." 
Labor organizations shall not be construed to be illegal combinations Or 
conspiracies in restraint of trade under federal anti-trust laws. 

"No preliminary injunction shall be issued without notice to the opposite 
party." No temporary restraining order shall be granted similar notice, 
unless it shall specifically show that immediate and irreparable injury will 
result before notice can be served and a hearing had thereon : and every tem- 
porary restraining order granted shall define the injury, state why it is irrep- 
arable and why the order was granted without notice, shall expire in not 
more than ten days unless extended for good cause, and shall provide for a 
hearing (on whether a preliminary injunction shall issue) which shall take 

1 P. s8. 



474 OUTLINES OF ECONOMICS 

precedence of all matters before the court except older matters of the same 
character. Proper bonds shall be executed to compensate for damages 
resulting from an injunction improvidently granted; every injunction or 
restraining order shall describe specifically and in reasonable detail the act 
sought to be restrained; and shall be binding only upon the parties to the 
suit, their officers, agents, servants, employees, and attorneys, or those par- 
ticipating with them, and who shall have received actual notice of the same. 
In contempt proceedings for violating any injunction or order forbidding 
an act which is also a criminal offense, the accused may demand trial by jury, 
and penalties are limited, in the case of natural persons. Judgments of con- 
viction may be reviewed upon writ of error as in criminal cases ; but these 
provisions do not relate to contempts committed in the presence of the court, 
nor to contempts committed in disobedience of any lawful order entered in 
any suit prosecuted on behalf of the United States. 

"And no such restraining order or injunction {i.e. in labor disputes) shall 
prohibit any person or persons, whether singly or in concert, from terminat- 
ing any relation of employment, or from ceasing to perform any work or 
labor, or from recommending, advising, or persuading others by peaceful 
means so to do ; or from attending at any place where any such person or 
persons may lawfully be, for the purpose of peacefully obtaining or com- 
municating information, or from peacefully persuading any person to work 
or to abstain from working ; or from ceasing to patronize or to employ any 
party to such dispute, or from recommending, advising, or persuading others 
by peaceful and lawful means so to do ; or from paying or giving to, or with- 
holding from, any person engaged in such dispute, any strike benefits or other 
moneys or things of value ; or from peaceably assembling in a lawful manner, 
and for lawful purposes; or from doing any act or thing which might lawfully 
be done in the absence of such dispute by any party thereto ; nor shall any of 
the acts specified in this paragraph he considered or held to be violations of any 
law of the United States." 

The most important provisions of the Clayton Act are those 
which we have italicized and which apparently provide that a 
combination of workmen may lawfully do in a labor dispute 
anything that any party thereto might lawfully do in the 
absence of the dispute. Whether this is wise or not time alone 
can tell. On the surface everything seems to support the con- 
clusion that men in concert should be permitted to do what 
they may do singly. If the right to work is property, so also 
is the right to quit work, and both are equally guaranteed by 
the federal constitution. An individual not under contract 
may quit working for an employer or dealing with a merchant 



LABOR LEGISLATION 475 

for any reason or no reason. Why, it is confidently asked, 
may groups of men not do the same? As a railroad engineer 
may quit work practically when he likes, why should not the 
Brotherhood of Locomotive Engineers quit work as a body when 
it pleases the organization, and thus tie up the entire railroad 
traffic of the country, for the purpose, say, of assisting the rail- 
road conductors of one district in refusing traffic from another 
district in which a strike has been declared? 

These questions carry in part their own answer. Many 
acts which are either harmless or trivial when performed by an 
individual become exceedingly injurious when swollen by 
concert and combination. A general strike or boycott for 
trivial or malicious ends cannot by logic-chopping be made 
anything else than impolitic and wrong. All this appears 
plain when we reverse the case and pass judgment upon what 
are practically the same acts when performed by employers. 
A sympathetic lockout, ordered against one innocent union, 
say of freight handlers, in order to prevent them from voting 
funds to assist the strike of a union of railroad telegraphers, 
for instance, would bring general criticism against the employers 
who ordered it; but it is essentially the same in principle as 
the sympathetic strike. The black-list — • which has almost 
no avowed friends — is in essence similar to the indirect boy- 
cott or strike to secure the discharge of a non-union man. The 
simple truth is that many things are dangerous when partici- 
pated in by great numbers, which are not so when performed 
by individuals. 

The Clayton Act does not remove all the safeguards against 
harmful combination. Most of the states still have anti- 
trust acts and laws against unlawful combination. Moreover, 
if we have not had general strikes and nation-wide boycotts in 
the past, it is not because the laws or the court decisions have 
prevented them. The inherent difficulties in the way of their 
successful consummation, and the sense of social responsibility 
among trade unionists and the working classes generally, furnish 
the real protection. The real danger is that the new legisla- 
tion will be interpreted as creating sound moral sanctions for 



476 OUTLINES OF ECONOMICS 

things which may be inherently unfair or immoral. If trade 
unionists and employers do not permit this legislation to blind 
their moral judgments, and remember that the removal of a 
legal ban from an action does not necessarily make that action 
under all circumstances either expedient or justifiable, then it 
is probable on the whole that the new legislation will result in 
more good than harm. 

The new law has the virtue of equalizing things. The sym- 
pathetic lockout and the black-list cannot in practice be denied 
to the employers. They can use them because they can use 
them secretly ; because the president of a great corporation or a 
small board of directors may maintain a black-list or order a 
sympathetic lockout so quietly that it would be impossible to 
prove their nature or for exactly what purposes they were 
declared. The trade union, on the other hand, must act in 
open concert, after legislative action, the nature and purpose 
of which can with difficulty be concealed. Many of the pro- 
ceedings must be formally recorded. The new federal law 
puts the employer and the union on a more equal footing ; al- 
though it ignores the vast interests of the public and removes 
legal penalties from actions which are often morally wrong 
and socially dangerous. In the end it will probably lead to the 
full exercise by the state of the right to suppress any black-list, 
lockout, strike, or boycott which becomes so extensive or 
offensive as to shock the public sense of fair play or seriously 
menace public welfare. 

Child Labor Laws. — The class of laws which we have been 
considering has been designed to relieve the laborer from ancient 
disabilities, so that he may be enabled in combination with 
his fellows to help himself. Most modern labor laws, however, 
are of a different type. They assume that the welfare of labor 
is of peculiar importance to society and that the state is there- 
fore warranted in protecting the wage-earning classes, openly 
and frankly. Perhaps the earliest and most typical legisla- 
tion enacted in this spirit is the child labor law. 

The problem of child labor is frequently misconstrued. The 
principal reason why children work is not found in the needy 



LABOR LEGISLATION 477 

■widow, the abandoned wife, or the stony-hearted employer. 
The principal causes of child labor are the restlessness of the 
child ; the failure of ordinary school training to hold his atten- 
tion and arouse his ambition ; and the ignorance or selfishness 
of parents. And the evil consists, principally, in the fact that 
the child who goes to work early usually gets into a " blind 
alley " occupation, and is thus prevented from developing his 
full potential earning power. His ability to serve both himself 
and society is curtailed by his excessively early start. " The 
better occupation either will not receive the young child at all, 
or wants him with more schooling, or offers such a low initial 
wage that both child and parent turn to the mill, with its greater 
present wage opportunities." ^ The wage in the low-grade 
occupation is at first relatively high, but in three or four years 
the boy has reached his maximum earning capacity and early 
marriage fastens him to the job. The boy who begins at six- 
teen /ears or later soon catches his less fortunate brother, and 
in a comparatively few years is earning a superior wage. As 
a foundation for real promotion and advancement the work 
which children between fourteen and sixteen years of age do 
has usually little value. 

It is thus plain that the problem of child labor is positive 
and constructive, not merely negative. It avails little to pro- 
hibit children from working at this or that; agencies must be 
provided helpfully to guide their activities. Already the 
most advanced states have incorporated in their laws a pro- 
vision requiring employers of child labor to give the children 
a specified amount of vocational training, or time to secure 
such training, in institutions provided by the state. More 
important still, agencies are being established to determine by 
physical and psychological tests whether children who have com- 
pleted the required schooling are really fitted to enter industry, 
and what kinds of work they are best fitted to undertake.^ 

1 Susan M. Kingsbury, "The Relation of Children to the Industries," in Report 
of Massachusetts Commission on Industrial and Technical Education, p. 44. 

1 See Mental and Physical Measurements of Working Children, by Helen Thompson 
Wooley and Charlotte Rust Fischer. 



478 OUTLINES OF ECONOMICS 

The beginnings are tentative and the work difficult. But 
the period draws to an end in which ignorant children drift 
or are pushed by ignorant parents into the work whicli lies 
neatest at hand ; and the time approaches when the most care- 
ful thought will be given to the selection of one's life work and 
the training for it. 

Chil\i labor laws differ greatly in the different states, and the 
resulting inequality of burden upon competing employers so 
complicates the problem that, in 1916, Congress enacted a law 
debarring from interstate commerce goods produced by very 
young children — leaving each state to legislate as it sees fit 
about products confined to intrastate trade. This, in our 
opinion, should be productive of far more good than evil. But 
the constitutionality of this new federal legislation is involved 
in grave doubt, and the new statute is in some respects 
unfortunately worded, so that its exact scope is not yet 
clear. 

A good state child labor law, it is now generally conceded, 
should prohibit the employment of all children under fourteen, 
and of all children under a higher age limit who are undersized, 
weakly, or illiterate. " Young persons " who are deficient in 
the fundamental requirements of an English education should 
be compelled, where possible, to attend a continuation school. 
Work in " immoral " or dangerous occupations, at night, or in 
excess of eight hours per day should be forbidden for all children 
under the higher age limit. 

The successful enforcement of such laws has been found diffi- 
cult. Birth or baptismal certificates, or other similar evidences 
of age, have to be procured from parents ; certificates of attend- 
ance and proficiency from school authorities ; examinations 
of health and educational requirements must be made; and 
employers required to demand, file, and return employment 
certificates. The community must maintain and properly 
support factory inspectors and health and school attendance 
officers in adequate numbers, with power to prosecute viola- 
tions of the law and with secure tenure of office. The com- 
munity should further provide for dependent families which 



LABOR LEGISLATION 479 

need the earnings of their children, keep birth records, and 
maintain schools fitted to hold the attention of the child and 
properly train him for his life work. " The best child labor 
law is a compulsory school law covering forty weeks in the year 
and requiring the attendance of all children under fourteen years 
of age." ^ 

The Labor of Women. — The labor of women is not in itself 
a problem which calls for legislation. The evil consists in work- 
ing under conditions which undermine health and morals, or 
for inadequate wages. It is impossible to describe here in 
detail the various laws which have been passed relating to the 
employment of women. Women are subject to the " factory 
acts " relating to sanitation, safety, and occupational diseases, 
and to general statutes regulating production in tenement 
houses and the time, frequency, and character of wage pay- 
ments. In the more advanced states also, the labor of women 
in manufacturing, mechanical, and mercantile establishments 
is likely to be safeguarded by laws limiting the hours of labor, 
prohibiting night work and continuous employment for more 
than six hours, for example, without an interval for meals ; provid- 
ing and permitting the use of suitable seats ; requiring separate 
and sanitary toilet facilities; prohibiting the employment 
(knowingly) of women within two weeks before or four weeks 
after childbirth ; and — in Massachusetts for example — 
directing local authorities to furnish responsible mothers having 
dependent children sufficient aid " to enable the mothers to 
bring up their children properly in their own homes." 

Until very recent years, regulations similar to the above 
represented the extreme limit to which any American state 
had gone in the protection of women. And even the consti- 
tutionality of such regulation was in grave doubt, for an im- 
portant statute limiting the hours of labor had been declared 
unconstitutional by the highest court in Illinois, and in New 
York a statute prohibiting night work had been similarly 
annulled, on the general grounds that they infringed the free- 

1 Cf. Florence Kelly, Some Ethical Gains Through Labor Legislation, pp. 98, 99, 
and passim. 



48o OUTLINES OF ECONOMICS 

dom of contract and were " unduly discriminatory between 
citizens," the court remarking (in the New York decision) " that 
woman is no more the ward of the state than is man." But 
under the more Hberal leadership of the Supreme Court of 
the United States, both of the state courts in question have 
recently reversed these decisions and have sanctioned similar 
laws as reasonable health regulations, looking not only to the 
protection of the individual woman but to the " welfare of the 
race." ^ 

Minimum Wage Laws for "Women. — In about a fourth of 
the states minimum wage laws have been passed, with the gen- 
eral object of requiring that wages paid in certain occupations 
shall be sufficient to provide for a woman's normal needs " re- 
garded as a human being living in a civilized community." 
Whether these statutes will be effective time alone can tell, but 
their passage marks a revolution in the social and legislative 
philosophy of this country. 

Minimum wage laws were first adopted by the Australian 
state of Victoria in 1896 to regulate wages and other conditions 
of labor in the " sweated trades." Trades or industries in 
which wages are particularly low are usually singled out by 
legislation, though in Victoria the government may apply the 
system to additional trades by administrative order. These 
wage boards, as we have seen in the preceding chapter, are 
designed to induce compulsory collective bargaining, in which 
the state participates by compelling employers and employees 
to fix standard conditions of employment. In England and 
this country the legislation is as yet much more tentative 
and restricted. " The outstanding characteristics of the Ameri- 
can minimum wage legislation compared with that of Eng- 
land, Australia, and New Zealand are these: The first is 
its omission of men ; the second is its reference to the 
welfare of the people as a whole; the third, which is re- 
sponsible for both the others, is its subordination to the courts 
on the grounds of constitutionality, entailing the practice of 
placing upon American states the burden of proof that they 

1 L. D. Clark, The Law of the Employment of Labor, p. 103. 



LABOR LEGISLATION 481 

are acting within their police powers when they create such 
wage commissions and wage boards or conferences." ^ Some 
of the American laws, it may be added, make no provisions for 
joint wage boards of the Australasian type, but provide that 
the minimum wage shall be fixed directly by a state labor or 
industrial commission. 

The general principles of minimum wage legislation are 
simple. In many trades the majority of the workers do not 
receive enough wages to maintain their physical efficiency. Of 
these sub-standard wage workers a large number are partially 
supported by other members of the family, a considerable num- 
ber are assisted by charity, a few eke out their living by inter- 
mittent or regular prostitution, and some " actually die of 
under-nutrition and worry." ^ The work as a rule is simple 
and the supply of labor excessive. Usually there is no labor 
organization. The workers are weak arid the wage is fixed 
by individual bargaining in which the predominant force is 
sometimes the rapacity of the employer. The tendency towards 
a uniform or standard wage in many of these trades seems to 
have been checked by the absence of labor organization, and 
competing establishments in the same industry are found again 
and again paying strikingly different wages for the same grade 
of labor. 

It is held, in short, that trades which pay less than a living 
wage are parasitic ; that they constitute a positive drain upon 
society at large, and that any measures necessary to place these 
trades on a self-supporting basis are both justifiable and econom- 
ically helpful. The establishment of a minimum wage is 
expected to force a certain number of slow and incompetent 
workers out of employment, although provision is usually 
made to permit them to work under special permits. But 
that society should be forced openly and frankly to deal with 
and take care of its incompetent workers is regarded as an ad- 
vantage. It is expected that such legislation in some instances 

1 Florence Kelley, in The Survey, vol. xxxiii, p. 487. 

2 H. R. Seager, "The Theory of the Minimuni Wage," American Labor Legislation 
Review, vol. iii, No. i, p. 84. 

21 



482 OUTLINES OF ECONOMICS 

will result in increased prices. But the consumer is expected 
to bear his fair share in supporting those who supply his needs, 
and both a priori analysis and experience in Australia and Eng- 
land make it probable that the rise of wages would not be 
accompanied by a corresponding rise in prices.^ Finally it 
is expected that the increase in wages will compel reorganization 
of the parasitical trades so that in the end the cost of produc- 
tion will be decreased rather than increased. Incidentally 
the operation of the wage boards is expected to stimulate or- 
ganization among the wage workers cqncerned and to react 
favorably upon immigration. Immigrants are less likely to 
come, many believe, if they know in advance that they must 
be able to earn the minimum wage or else leave the country. 
Price cutting in the labor market will be checked ; and the 
increase in wages will focus competition upon the quality and 
efficiency of the laborer. Most important of all, perhaps, the 
system is expected to compel a wider and more effective use of 
labor-saving machinery. 

Minimum wage legislation slowly introduced and carefully 
administered meets the test both of economic theory and actual 
experience. In Victoria the legislation which was at first 
doubtfully applied to six trades has now been made applicable 
to 141 ; and 150,000 workers in a population numbering less 
than one and one half million " have the minimum wages in 
their trades prescribed by law." Vigorously opposed by the 
employers on its introduction, it seems from reports of disin- 
terested investigators to have established itself on a firm founda- 
tion. There is yet some opposition to details of the law and 
vigorous criticism of the way in which it is administered; but 
from all that can be learned those who desire to do away with 
this system of regulation constitute a very small minority. In 
England the results seem equally favorable. Nothing revo- 
lutionary has been accomplished, but the system has demon- 
strated that it is practicable, even in highly complicated trades ; 
that it can be trusted to raise wages without seriously disturb- 
ing prices ; that it mildly stimulates organization among work- 
* C/. N. I. Stone, in The Survey, vol. xxxiii, p. 514. 



LABOR LEGISLATION 483 

ers who need organized effort to better themselves; that it 
compels serious study and pubhc investigation of trades which 
need both ; and that it is not productive of serious evils. The 
minimum wage has not become the maximum nor has the 
operation of the act resulted " in wholesale dismissals of old 
and slow workers. The predominant method of payment in 
the scheduled trades is by piece, and where this is the case the 
employer who has fixed piece rates yielding the equivalent of 
the time rate to the ' ordinary worker ' runs no risk of penalty 
if his sub-ordinary worker fails to reach that amount by reason 
of incapacity or advanced age." ^ 

So far as economic theory is concerned, there is no reason 
to believe the minimum wage proposition unsound. The es- 
tablishment of minimum standards of sanitation and safety in 
Germany does not seem to have hurt industry there, and there 
is no reason to believe that the establishment of minimum wage 
standards would do so. Without regulation much of the com- 
petitive fight centers about the mere money wage. A poor 
workman may be more profitable to the employer than a skilled 
workman provided the poor workman can be secured for a small 
enough fraction of the wage it would be necessary to pay to 
the skilled workman. Establish a dead line — or better, a 
health line — and the emphasis will be placed upon efficiency 
instead of cheapness. Wage earners will have to meet higher 
and better standards. The competitive struggle will thus 
operate to evoke efficient rather than low-paid workmen. 
And the higher cost of labor will help to force the introduction 
of better machinery and better methods of organization. 

Obviously, not all the claims made for this system will bear 
scientific scrutiny. There is, for instance, probably more 
error than truth in the contention that every industry which 
pays its minor workers less than a living wage is a detriment 
rather than a help, an industrial parasite sopping the economic 
strength of a community. Until a far better distribution of 
the labor force has been secured, there will continue to be in 

1 Constance Smith, "Working of the Trade Boards Act," Journal of Political 
Economy, vol. xxii, p. 625. 



484 OUTLINES OF ECONOMICS 

all probability a surplus of workers who cannot earn a living 
wage and yet had better earn a supplementary wage than be 
idle. There were in 1910, for instance, in this country 1,847,600 
females between the ages of 16 and 20, inclusive, engaged in 
gainful occupations. Young women might possibly better 
spend these years in training for their life-work, including house- 
keeping and the difi&cult vocation of marriage. But until 
adequate provision for such training is made, young women of 
this age had better be employed at wages which will tend to 
make the family income more adequate than not to be employed 
at all. After all, however, these are minor modifications of 
the theory upon which the minimum wage program rests. 
That standards should be adopted, including a wage standard, 
which both employers and employees must meet, is on the whole 
consistent with the best economic and social theory. 

Some trade unionists oppose minimum wage laws on the 
grounds that the minima will become maxima and that wages 
should not be regulated by law. But the first charge has been 
disproved by experience, and the minimum wage at its best is 
a program for compulsory collective bargaining, not for the 
regulation of wages by statute. It aims to introduce into un- 
skilled vocations what are essentially trade-union methods of 
standardization, and the criticisms which are directed against 
it apply equally well to trade-union procedure. 

Factory Acts. — Constitutional guarantees, particularly that 
of free contract, prevent in this country the general regulation 
of the labor of adult men, but under the police power the states 
have the right, indeed in the language of the Supreme Court, 
" it is among their plain duties," to regulate the physical condi- 
tions of employment so that accidents and occupational diseases 
may be minimized. These regulations, frequently referred to 
as factory acts, are typified by the familiar laws requiring proper 
fire escapes, the removal of dust or noxious vapors by fans, the 
placing of guards about dangerous machinery, the installation 
of mechanical belt shifters, and connection by bells or tubes 
between rooms in which machinery is used and the engine room. 
Such laws have now been adopted in most of the states, but 



LABOR LEGISLATION 485 

their enforcement in many states has been very ineffective. 
In 1 9 13 there were fifteen states with nearly a milHon wage 
earners in manufacturing and mechanical industries which had 
practically no provision for factory inspectors. And even 
where factory inspection is provided, it has too frequently been 
half-hearted, inexpert, and emasculated by political interference. 
In one state, " where the chief factory inspector divides his time 
between conducting a livery stable he owns and the business of 
caring for some 30,000 factory wage earners, I found him con- 
tributing a remarkably concise annual report of exactly four- 
teen words. It reads, under date of July i, as follows: 'I 
have visited the same factories as last year and find conditions 
the same.' " ^ 

While politics and administrative ineptitude have seriously 
crippled factory regulation in this country, the truth is that 
the problem was a new and difiicult one and that there were 
procurable few or no real experts until very recent years. Very 
recently, however, great improvement has been made both 
in the laws and their administration. Wisconsin, Massachu- 
setts, New York, and other states have gone far towards solving 
the administrative problem by placing appointments on the 
civil service basis and consolidating powers previously lodged 
with police, factory inspectors, and health commissioners into 
one industrial or labor commission, with general power to enforce 
the rules necessary to provide reasonable sanitation and safety. 
In this way the necessary elasticity of rule and standard has 
been secured ; and in adopting rules or standards the coopera- 
tion of employers and labor organizations has been secured, 
thus insuring more practical rules and the good will of those to 
whom these rules apply. Regulation by the state can never 
become effective until responsibility and power are centralized 
and the responsible administrative head given sufficient dis- 
cretion nicely to adapt regulations to the subtle complexities 
of modern industry. With employers, employees, and factory 
inspectors working together under practicable regulations in 

1 E. F. Brown, "The Efficiency of Present Factory Inspection Machinery in 
the United States," American Labor Legislation Review, vol. iii, No. i, pp. 27-28. 



486 OUTLINES OF ECONOMICS 

whose formulation all three have cooperated, rapid progress 
has recently been made in the prevention of accidents and 
equally gratifying improvement has been made in the methods 
of compensating for accidents. 

Employers' Liability. — Under the common law of employ- 
ers' liability, the employer is under obligation to provide his 
workmen with a reasonably safe place in which to work, with 
reasonably safe machinery, and with reasonably prudent and 
competent fellow workmen; and the employer is liable in 
damages for any accident to his workmen resulting from failure 
to display this ordinary prudence and care, as well as from the 
similar failure or negligence of any superintendent, overseer, 
or vice-principal authorized to issue orders in his name. When 
the employer has observed the ordinary precautions of a reason- 
ably prudent man, however, the employee assumes all the haz- 
ards incident to the employment or arising from the negligence 
of fellow servants ; and even though the employer is negligent, 
the employee cannot recover damages for an accident, if the 
employee was aware of the employer's negligence and volun- 
tarily accepted the risk, or if the employee has been guilty of 
additional or contributory negligence. 

This, in bare outline, is the common-law foundation of the 
doctrine of employers' liability. It has been modified inces- 
santly by statute law and by changing interpretation of the 
courts ; it is vague, uncertain, and legalistic in the worst sense. 
Under it not more than ten per cent of the victims of indus- 
trial accidents received any compensation, and of the damages 
paid by employers the victims received on the average probably 
less than 50 per cent. The rest went for court costs and lawyers' 
fees. A class of professional accident attorneys, " ambulance 
chasers," who exploited industrial accidents for their own rather 
than the victims' benefit, appeared in most industrial centers ; 
ignorant juries decided on the difficult facts in the most capri- 
cious ways, now refusing relief in deserving cases, again voting 
excessive damages for trivial or perhaps simulated injuries ; 
the cases filled the courts ; decisions turned upon hair-splitting 
distinctions and metaphysical niceties ; the humane employer, 



LABOR LEGISLATION 487 

the conscientious lawyer, the far-sighted judge, workingmen, 
and the general public became, it is hardly too much to say, 
disgusted with the inapplicability and bungling unsuitability 
of the doctrine of employers' liability properly to deal with the 
grave social problem arising from industrial accidents. 

Attempts to solve this problem, as stated above, first took 
the form of incessant amendment of the old law. The fellow- 
servant doctrine (that the employer was not responsible for 
accidents arising from the negligence of co-employees as distin- 
guished from vice-principals) was curtailed in some states by 
confining " fellow servants " to those employed in coordinate 
occupations immediately associated with the victim, and the 
employer's defenses of " assumption of risk " and " contributory 
negligence " were limited and in some jurisdictions almost 
abolished. But the truth is that the whole social philosophy 
underlying the law of employers' liability was mistaken, " not 
so much unjust as wholly inapplicable." It misconceived 
the nature of the social problem involved and offered remedies 
that were wholly ineffectual. It attempted — so far as one 
can discover behind it any real rational philosophy — to single 
out those accidents for which the employer was to blame and 
to compensate workmen in accordance with the damage resulting 
from the employer's negligence. Investigation shows, however, 
that the employer is responsible for only a minority of the 
accidents which occur. The victim himself, his fellow workers, 
and, most important of all, the occupational risk itself are re- 
sponsible for the great majority of accidents. But the victim's 
need and that of his family are just as great when the accident 
results from the victim's negligence as when it results from the 
employer's negligence. It is not a question of individual fault 
and punishment for that fault ; it is a question of industrial 
or social loss and insurance against that loss. The government 
should of course compel both employers and employees to take 
every reasonable precaution against accident, by unequivocal 
law or administrative order ; and every infraction of the law 
should lead to criminal indictment, not civil action. But even 
if this were accomplished, there would still remain a large 



488 OUTLINES OF ECONOMICS 

number of industrial accidents which if not compensated for 
would lead to poverty, unemployment, and the suffering of 
innocent women and children. 

That the burden of industrial accidents should be borne by 
the industry itself or the consumer and not by the laborer or 
his family is very generally recognized ; and most foreign coun- 
tries, together with the federal government and more than half 
of the states, have replaced or supplemented the old law of 
employers' liability with workmen's compensation acts. The 
laws are described and discussed in a later chapter, on Insur- 
ance. They have worked well : not perfectly, but with much 
more certainty and with far less cost than the old laws. Defects 
naturally exist in the new system which should be remedied 
in the future. The usual compensation is too low to indemnify 
the victim and his family adequately for the loss resulting from 
the accident, and the limitation of payments for permanent 
disability to four or six years or less is illogical and will cause 
hardship. But the new system is so much superior to the old 
that, despite these defects, its adoption must be regarded as 
a noteworthy step in social progress achieved through legis- 
lation. As a concrete contrast with the awkward, expensive, 
capricious working of the old liability law, the results of the 
operation of the Wisconsin compensation act during the year 
ended June 30, 191 5, are suggestive of the improvement effected 
by the change. Of all the industrial accidents occurring that 
year, 93 per cent were settled between the employers and work- 
men with no outside interference beyond a simple " approval " 
by the state Industrial Commission ; 3 per cent of the cases 
were carried to the industrial commission for adjustment ; 
and only one fifth of i per cent was carried to the courts. The 
injured workmen received for indemnity and medical expense 
$1,350,000, while the administrative cost to the state was only 

Philosophy of Labor Legislation. — In the preceding sketch 
it has been possible only in the most superficial way to call 
attention to a few of the more important modern labor laws. 
It is equally impossible to discuss adequately the general aspects 



LABOR LEGISLATION 489 

of the labor movement as it expresses itself in legislative action. 
In conclusion, however, it may be suggestive in a rather dog- 
matic way to pass in review some of the broader aspects of this 
movement : 

Mercantilism and its alleged failure, or the breakdown of 
old labor legislation in the seventeenth and eighteenth cen- 
turies, furnish no adequate reason for concluding that the new 
legislation will fail. The old laws were enacted by a ruling 
minority in behalf of that minority. They had to contend 
with the persistent and growing opposition of a large ma- 
jority of the people. They lay athwart the path of democracy. 
The new laws have a much greater chance of success because 
they cannot be passed until they have the support of a ma- 
jority, and we may now reasonably look for an administration 
thoroughly in sympathy with their purposes. 

Administratively, an improved mechanism has been developed 
in the industrial, labor, or welfare commission. From the stand- 
point of labor legislation the tripartite division of American 
government has been deeply unfortunate. Legislatures have 
enacted laws, courts have passed upon them, and executives 
have administered them who did not understand the conditions 
and technical facts with which they dealt. More legislative 
power and more judicial power must be lodged in labor com- 
missions, manned by real experts (whom we are just beginning 
to train) and empowered to deal with complex labor problems 
by administrative orders or, more properly perhaps, legislative 
and executive orders. The original formulation of general 
social policy must be left to the legislature ; ultimate constitu- 
tional and judicial questions must remain with the courts ; but 
all special questions, legislative, judicial, and administrative, 
should be left as fully as possible to a body supplied with means 
and time to learn the technical facts and to enlist both employers 
and employees in formulating and then observing the details 
of the law. 

So far as constitutional questions are concerned, the main 
battle in the courts has, we believe, been won. Individualism 
and freedom of contract have constituted in the past a chronic 



490 OUTLINES OF ECONOMICS 

American disease ; but an adequate antitoxin has been developed 
in the police power. The doctrine of the police power raises 
essentially a question of fact : does the condition in question gen- 
uinely menace the health or morals or safety of the community ? 
Because this is primarily a question of fact, it is vitally im- 
portant that we should have commissions or officials empowered 
to get the facts in an impartial and authoritative way. When 
we have the facts we shall recognize fully that " liberty " is a 
composite and mutually contradictory term; that there are 
liberties rather than one single liberty ; that to preserve a 
deeper and more genuine liberty we must frequently sacrifice 
liberties of a smaller and more superficial character, and to 
preserve the liberty of the many it is sometimes necessary to 
restrain the liberty of the few. If there is an inalienable right 
of free contract, may an individual in the exercise of that right 
bind himself to slavery for life ? . " 

Finally it is being found that this protective legislation — ■ 
protective against poverty and exploitation either by persons 
or circumstances (the last is far the more important) — does 
not pauperize or weaken human fiber, or check the competitive 
struggle for existence upon which so much is believed to depend. 
Underfeeding, undereducation, underthinking, all the hand- 
to-mouth vicissitudes that accompany abject poverty, under- 
mine human fiber and pauperize far more effectually than state 
regulation or assistance can ever do. Moreover, the modern 
labor law is the antithesis of paternalism. It is the collective 
way by which the wage-earning masses help themselves ; and 
it is political because the evil which it seeks to remedy is political 
as well as individual. " Of all national resources labor is by 
far the most important. So important is it that one may 
almost say that all else depends upon it. Not until a nation 
has secured a body of sturdy, skillful and contented workers 
can it be said to have met the first requisite to national efficiency. 
... As in the past the nation that would succeed had to 
apply itself to the training of its soldiers, so now it must apply 
itself to the training of its industrial workers. We are appalled 
at the suffering, loss of life, and destruction of wealth entailed 



LABOR LEGISLATION 49 1 

by war and preparation for war. They are as nothing compared 
with the misery, sickness, and death now due to the failure of 
society properly to control the conditions under which industrial 
work shall be performed. No one can calculate the loss daily 
taking place as the result of the use of feeble, untrained, dis- 
contented workers." ^ Labor legislation represents above all 
else an organized effort to achieve national and social efi&ciency. 

QUESTIONS 

1. Under what circumstances is the labor law used to determine condi- 
tions of employment? What are its characteristics in this connection? 
What differences are found in the determination of conditions of employ- 
ment by law and by a strong trade union ? 

2. What is the difference between a primary and an indirect or compound 
boycott? Is the latter lawful in the jurisdiction in which you live? Is a 
strike to prevent the employment of non-union men lawful? 

3. Does the an ti- trust act of your state apply to labor organizations? 
What is a conspiracy ? and what are the peculiar characteristics of the law 
of conspiracy? 

4. Against what aspects or characteristics of the injunction do trade 
unionists protest? 

5. Summarize the child labor laws of your state and those relating to 
industrial education, continuation schools, and mothers' pensions. What 
arguments have been advanced against mothers' pensions ? 

6. Do minimum wage laws operate to reduce all wages to the legal min- 
imum? Summarize evidence on this point from the Frankfurter-Goldmark 
brief and other sources. 

7. What bearing has the minimum wage on the immigration problem? 
Is it socially expedient that minors living in families with adequate incomes 
should be prohibited from working for less than the living wage ? 

8. Does compulsory insurance against sickness and old age tend to under- 
mine or strengthen individual thrift? Give reasons. 

9. Briefly summarize the law on employers' liability in your state; or 
if it has a workmen's compensation act, summarize the results of that law 
as given in the latest published statistics. 

REFERENCES 

(See also references for Chapter XXII.) 

American Labor Legislation Review (quarterly). 

Andrews, Irene. Minimum Wage Legislation (with select bibliography on 
the minimum wage). 

1 W. F. Willoughby, in American Labor Legislation Review, vol. iv, p. 44. 



492 OUTLINES OF ECONOMICS 

AvES, Ernest. Report to the Secretary of State for the Home Department on 
Wages Boards and Industrial Conciliation and Arbitration Acts of Aus- 
tralia and New Zealand. 

Beveridge, W. H. Unemployment. A Problem of hidustry. 

Clark, L. D. The Law of the Employment of Labor. 

Clark, V. S. The Labor Movement in Australasia. 

Commons, J. R., and Andrews, J. B. Principles of Labor Legislation. 

Dicey, A. V. Relation Between Law and Public Opinion in England in the 
Nineteenth Century. 

Frankfurter, Felix, and Goldmark, Josephine. The Case for the 
Shorter Work Day (2 vols.). (Brief in the Oregon ten-hour-law case.) 

Goldmark, Josephine. Fatigue. 

HuTCHiNS, B. L., and Harrison, A. A History of Factory Legislation. 

RuBiNOW, I. M. Social Insurance. 

Stimson, F. J. Popular Law Making; Handbook to the Labor Law of 
the United States. 

United States Bureau of Labor Statistics. Bulletin (Separate series upon 
(a) Labor Laws of the United States (including decisions of courts 
relating to labor) , (b) Foreign Labor Laws, (c) Workmen's Insurance 
and Compensation) ; Report on Condition of Woman and Child Wage 
Earners in the United States (19 volumes). 

Webb, Sidney and Beatrice. The Prevention of Destitution. 



CHAPTER XXIV 

INTEREST 

Interest is the price paid for the services of capital. It appears 
in two forms : loan interest, the amount paid by one man to an- 
other for the use of money or goods owned by the latter, and 
imputed interest, that portion of the value of the products of 
industry which is attributed or imputed to the services of capital, 
as distinct from the services of land and labor. Interest is usu- 
ally measured as a percentage of the money value of capital, and 
this, coupled with the fact that capital is often lent in the form 
of money, has led to the prevalence of the idea that interest is a 
payment for the use of money. This is only a partial descrip- 
tion of interest, however, for it does not include imputed interest 
nor the loan interest paid in the form of rentals for the use of 
many forms of capital — buildings, for example. 

Objections to Interest Taking. — It is only in modern times that interest 
has been generally considered a legitimate and necessary form of income. 
The strong denunciations of usury contained in both the Old and New Testa- 
ments are denunciations of interest taking, for the word "usury" formerly 
meant any kind of interest, and not merely excessive interest, as at present. 
The opinion of many classical writers is illustrated by Aristotle's dictum that 
" money was intended to be used in exchange, but not to increase at interest." 
During the greater part of the middle ages the authority and teaching of the 
church was set definitely against the taking of interest in any form. In the 
middle of the fourteenth century the prohibition of usury was incorporated 
in the civil law. These objections, however, had reference chiefly to loan 
interest, and interest on money lent for personal use at that ; for capital was 
not thought of as one of the factors in production until comparatively modern 
times. In fact, by the fifteenth century, when opportunities for the profitable 
use of money had appeared in such forms as the purchase of rights to receive 
land rents, or partnership ventures in trade (where interest was held to be 
justified by the risk incurred), the canonists (the writers on church law) 
admitted the legitimacy not only of such gainful employments of money, 

493 



494 OUTLINES OF ECONOMICS 

but also, in many cases, of interest on loans. The justification of loan inter- 
est took on at first many curious forms. It was regarded in some cases as 
a fine for delay in the repayment of the loan, so that lenders often resorted 
to the subterfuge of lending money gratuitously for a nominal period, the 
real agreement being that they were to get back their money principal, with 
a fine for the delay added, at a later date. In other cases loan interest was 
justified as a payment for the loss of the possible gains which the lender 
might have got by using his money himself. Usury, which at first meant any 
kind of loan interest, came to mean interest on money loans to relieve per- 
sonal needs, rather than for gainful employment, then interest on loans in 
which the element of risk was lacking, and finally, excessively high interest. 
Today the use of capital is so prominent a feature of our productive meth- 
ods that the legitimacy of interest is not generally questioned. Socialistic 
writers, however, insist that interest is only a result of the system of the pri- 
vate ownership of capital, and that with the abolition of private property in 
production goods what is now counted as interest would become part of the 
wages of labor. It is accordingly important that we should understand 
dearly why interest has to be paid, as well as that we should study the factors 
determining the rate of interest. We shall find, however, that the explana- 
tion of the necessity of interest is really a part of the explanation of the rate 
of interest. 

Inadequate Explanations of Interest. — An idea that naturally 
suggests itself is that interest has to be paid for the use of money 
because " money can be profitably employed in business." But 
this is only an attempt to explain loan interest by assuming the 
existence of imputed interest. What we want to know is why 
" money can be profitably employed in business." 

A similar, but somewhat more definite, attempt at an explana- 
tion is contained in the statement that interest is paid because 
capital is productive. It is pointed out that by the use of capital 
goods the product of industry is greatly increased over what 
could be produced by labor and land alone. This is, of course, 
true, but taken alone it does not explain interest. The problem 
of interest relates to the value of the product, not to the amount 
of the product. There is nothing in the mere quantity of the 
product, taken by itself, that gives value to it. Farmers have 
found more than once that a large wheat crop has sold for less 
in the aggregate than a small one. The real problem of in- 
terest is this : How can an entrepreneur, by the use of capital, 
increase the selling value of his product enough to not only pay 



INTEREST 495 

for the capital actually used up in production, but also to pay in 
addition a surplus in the form of interest upon the capital em- 
ployed? Nor can we say that " capital produces interest." 
It cannot be too strongly emphasized that neither land, nor labor, 
nor capital produces value. They are simply the instruments 
used in the production of things that command a price in the 
market because they satisfy human wants and will not be fur- 
nished except at a price. Part of the value of the product is 
imputed or attributed to capital in the form of interest, and it 
is because of its capacity to earn interest that capital is valued. 
To say that capital produces vafue is to reverse the true process. 
Capital goods produce (or aid in the production of) other goods, 
and the selling value of these produced goods is the cause of 
capital value. 

"Why Interest can be Paid. — We shall find the analysis of our 
problem somewhat simpler if we divide it into two parts : first, 
why interest is possible; and second, why interest must be paid. 
In discussing why interest can be paid, we shall assume that in- 
terest must be paid if capital is to be used in production, reserv- 
ing the discussion of the legitimacy of this assumption for the 
following section. 

It is the physical productivity of capital — the fact that 
capital can be used in cooperation with land and labor in the 
production of goods — that makes it possible for the entre- 
preneur to look upon part of his total money income as interest 
on his investment of capital. Now, as we have seen, the mere 
fact that capital is productive in the physical sense does not 
explain interest, but the fact that capital is used under the guid- 
ance of entrepreneurs in the production of goods does explain the 
possibility of interest. The mere physical productivity of land 
does not explain rent — land will grow weeds as well as wheat ; 
nor does the mere physical productivity of labor explain wages 
— some men have put years into the construction of perpetual- 
motion machines that are absolutely worthless. But it is the 
business of the entrepreneur to see that land and labor are used 
wisely ; and from his point of view they are used wisely if they 
are used in the production of things that consumers want, and 



496 OUTLINES OF ECONOMICS 

want intensely enough to pay such prices as will enable the 
entrepreneur to pay the rent of the land and the wages of the 
labor employed. Similarly, an entrepreneur will not employ 
capital in any kind of production unless the prices he expects to 
get for his products are such as to cover the expenses incurred 
in the use of capital. Nor will he knowingly use so much capital 
that his product will sell for less than a smaller product would 
have sold for, any more than he will knowingly produce an un- 
profitably large quantity of goods by the use of too much labor 
or too much land. 

On the one hand, the entrepreneur has to estimate the prices he 
will get for his products ; on the other hand, he has to estimate 
the productivity and the expense of land, labor, and capital. 
The expense of capital includes, first, the cost of the capital 
actually used up in production ; and second, interest on all of 
the capital used, whether " used up " or not (assuming, as previ- 
ously explained, the necessity of interest). The principles that 
will guide the entrepreneur as to the relative proportions of labor, 
land, and capital he will use have already been discussed in 
connection with the general subject of diminishing productivity. 
We may, however, emphasize again the fact that productivity 
must be attributed, not to " capital in general," but to specific 
units of specific kinds of capital, used in connection with definite 
amounts of land and labor; the productivity imputed to any 
particular unit of capital being the precise amount of product 
actually dependent upon the use of that particular unit — the 
amount by which the total product would be decreased if the 
unit in question were not used. An entrepreneur will increase 
his use of capital rather than of labor or land, when a given 
expense for any kind of capital will add more to his product 
than would a similar expense for labor or land. 

The Necessity of Interest. — Free goods, such as air or the 
force of gravitation, are productive in the physical sense, in 
that they are absolutely necessary to most forms of production. 
The surface of Lake Michigan is used in producing the service 
of transportation in essentially the same way as is capital in the 
form of a railway roadbed and track. But we cannot impute 



INTEREST 497 

productivity to specific units of free goods, for the simple reason 
that the amount of the product is not dependent on the utiliza- 
tion of any one unit of them. Any one cubic foot of air could be 
dispensed with ; we cannot even conceive of the force of gravita- 
tion as limited in quantity ; the Great Lakes furnish pathways 
that are more than sufficient for all the vessels that traverse 
them. We do impute productivity to the better lands that are 
used in production, because any one acre of them could not be 
withdrawn from use without a diminution in the product. 
The controlling reason for this difference is that the spontaneous 
supply of free goods is in excess of the use that is made of them ; 
while the supply of the better lands is limited as compared with 
the demand for them. This suggests at once why productivity 
has to be imputed to specific units of capital, and that is, that 
the supply of capital is limited. 

Why is the supply of capital limited ? This question leads us 
to examine the nature of the supply of capital. Imagine a 
society without capital carrying on its productive processes by 
the use of labor and land only. So long as the members of this 
community produce only what they consume directly, or (if, 
despite the absence of capital, money economy and a system of 
exchange may be imagined to prevail) so long as they spend all 
their money incomes for things used up immediately in the satis- 
faction of their wants, there will be no accumulation of capital. 
In order that capital shall be furnished, it is necessary that some 
members of the community turn aside from the production of 
things that are used in the immediate satisfaction of their wants 
and devote their time to the production of goods that will be 
used in further production. Whether they do this on their own 
account, or whether they are paid for their work while they are 
doing it by others, some postponement of the satisfaction of 
wants is necessary. In the one case those who produce the 
capital goods give up temporarily the satisfactions which they 
would have derived from the consumption goods they might 
have produced. In the other case, those who are devoting part 
of their money incomes to the payment of those who are pro- 
ducing capital goods are giving up the immediate satisfactions 



498 OUTLINES OF ECONOMICS 

which they might have secured with the money. In either case 
the production of capital involves the sacrifice of waiting on the 
part of some members of the community. 

But why should waiting be called a sacrifice ? Do not those 
who give up present satisfactions in order that capital goods 
may be produced get a full repayment if they get back in the 
form of the products of their capital goods as much as they, for 
the time being, give up? In other words, why should capital 
not be furnished for productive purposes if those who furnish the 
capital get back an exact equivalent (in price) for the amount of 
capital they have supplied ? Why should an extra payment, in 
the form of interest, be necessary to induce saving ? 

The answer to these questions is found in the difference between 
our present appraisals of things to be had now and things to be 
had in the future. We visualize the present more vividly than 
we do the future ; we yield sometimes to the temptation of satis- 
fying the. more trivial wants of the present, even when we know 
that we are thereby rendering uncertain the satisfaction of more 
important wants in the future ; and when we take considerable 
periods of time into account, we may reasonably say that the 
uncertainty of life itself gives us some ground for preferring 
present to possible future satisfactions. Notwithstanding the 
vast difference between civilized men and savages in this respect 
— for many of the latter seem to have absolutely no regard for 
future needs — the fact still remains that waiting is a sacrifice, 
and in order to induce the saving that is a prerequisite to the 
use of capital in industry, a premium or reward for waiting has 
to be paid in the form of interest. This fact is the most funda- 
mental thing in the explanation of interest. 

It must not be inferred that, in the actual economic life of to- 
day, no capital would be supplied if interest were not paid. 
There are other motives that induce men to save parts of their 
incomes. The desire to provide for old age and for such con- 
tingencies as sickness and accident, or to make provision for 
one's family in case of death, would result in a considerable 
amount of saving. The mere pride of accumulation, and the 
fact that the satisfaction of many important wants, such as the 



INTEREST 499 

desire to own a house, or the desire for foreign travel, necessitate 
the gradual accumulation of what is to most persons a consider- 
able sum of money, must also be given due weight. Moreover, 
none of these motives would in itself induce men to invest or 
lend their saved funds in productive undertakings if no interest 
at all were paid. In fact, this would be a matter of indifference, 
for savings might just as well be hoarded. But a very low 
interest premium would sufi&ce to overcome this indifference and 
to bring about their investment in productive undertakings. 
Even this low interest rate, however, would be sufficient to 
balance, in some additional cases, the difference between the 
intensity of present wants and the intensity of future wants, 
so that in these cases, in turn, spending or saving would be a 
matter of indifference — an indifference that would in its turn 
be overcome by a slight increase in the interest rate. In a 
similar way every increase in the interest rate would induce 
more persons to save and would induce many of those who were 
already saving a part of their incomes to save a larger propor- 
tion of them. 

At any given time, accordingly, the interest rate is consider- 
ably higher than is necessary to secure a large part of the waiting 
that devolves upon those who furnish capital funds for pro- 
ductive purposes. It is just high enough, however, to be a 
recompense for marginal waiting, which is the waiting that 
would not take place if the interest rate were any lower. If 
the interest rate is 5 per cent, a dollar today is worth a dollar 
and five cents a year from today, not to all savers, but to the 
marginal savers. 

Investment. — We have seen that the supply of capital 
originates in the fact that some people save part of their money 
incomes, and that interest has to be paid in order to induce this 
saving. Such persons are said to get an " income from their 
capital." Strictly speaking, their savings are not productive 
capital at all, in the sense in which the word " productive " is 
used in this book. Productive capital consists of the concrete 
material instruments of production, such as factory buildings, 
machines, raw materials, merchants' stocks of finished products, 



go© OUTLINES OF ICONOMlCS 

and the like. Savings are not productive capital in this ienge^ 
but the process by which they are transmuted into productive 
capital is a simple and familiar one. The simplest case is where 
the entrepreneur saves part of his own money income and uses 
his savings in the purchase of additional capital goods, the selling 
value of the products of which he estimates will be large enough 
to repay him for his waiting, as well as to replace his capital as it 
is Used up, that is, to earn interest for him as well as repay the 
principal. Or, the entrepreneur may borrow money directly 
from others who have saved it, agreeing to pay annual interest, 
and in addition to repay the amount of the loan — the principal 
— at some specified time. In the complex economy of the pres- 
ent, however, it very often happens that the entrepreneur who 
can use money profitably and the man who has surplus funds to 
invest do not arrange the transaction directly. Savings are 
" placed at interest " in savings banks, insurance companies, or 
other financial institutions, and it is to such institutions that the 
entrepreneur who thinks that he can use more capital profit- 
ably applies for loans. 

Very often the entrepreneur is a corporation rather than an 
individual, but the same three methods of obtaining capital are 
open to it. The corporation may choose to reinvest some of its 
net earnings in productive forms of capital rather than to pay 
them all out in dividends to its stockholders. When in need of 
money to meet a temporary emergency, the corporation may 
borrow from banks just as the individual entrepreneur does. 
When in need of money for more permanent investment in the 
durable forms of capital goods, the corporation usually issues its 
own interest-bearing obligations in the form of bonds, which it 
sells to banks, insurance companies, and other financial institu- 
tions, as well as to individuals. Bond issues are merely one way 
of borrowing money. But whether the money funds are fur- 
nished by the entrepreneur or by others, the formation of capital 
necessitates, first, the saving of parts of money incomes, and 
second, the use of the funds thus secured in the purchase of 
capital goods. The expression " investment of money " is used 
as a short way of describing this twofold process. 



INTEREST Sol 

The Replacement of Capital. — It is clear, then, that saving 
which necessitates waiting, is a prerequisite to the formation of 
new capital, that is, to an increase of the supply of capital already 
in existence. But at any given time the capital already in exist- 
ence forms a very large proportion of the total supply of capital, 
and it may be thought that the present interest rate does not 
affect this portion of the supply. We must, however, take into 
consideration the fact that almost all kinds of capital are being 
continually used up in production. This using up may be a 
matter of a single use, as in the case of fuel or raw materials, or it 
may be a gradual wearing out, as in the case of a machine, but 
such differences are differences in degree .of durability rather 
than differences in kind. 

As we have seen, the entrepreneur will normally not employ 
any given additional unit of capital unless he expects to get 
enough from the selling value of the added product to replace 
the capital actually used up in production as well as to pay 
interest. This means that if the entrepreneur's estimates prove 
correct, part of the money income he gets for his product may 
be regarded as a replacement fund, sufficient in amount to replace 
the capital used up in production. 

We must not, however, make the error of thinking of the 
replacement fund as definite in quantity. Whether or not any 
unit of capital produces enough to furnish a replacement fund, 
depends on whether the entrepreneur's estimate is a correct one. 
There is no reason why unproductive forms of capital should be 
kept intact in amount. He would be a foolish business man, for 
instance, who would keep reinvesting a certain amount of money 
^r^raw materials in the face of a diminishing demand for the fin- 
ished product. Even if enough income is earned to form a re- 
placement fund, the capital used up need not be replaced unless 
the entrepreneur so chooses. A farmer may have saved for 
years in order to buy a reaper. The reaper will enable him to 
raise more wheat, or, possibly, to produce the same amount of 
wheat at less expense. In either case it will mean an increase 
in his net money income. He may, if he chooses, set aside enough 
of this added income so that, when the first reaper wears out, his 



502 OUTLINES OF ECONOMICS 

accumulated funds will replace it. From one point of view we 
may say that in this way the reaper " replaces itself." But the 
farmer may, if he prefers, use all of his increased income in the 
purchase of additional comforts and luxuries for himself and his 
family. In deciding whether he will replace his capital or in- 
crease his present consumption, he will be guided by the same 
kind of an estimate of the relative importance of present and 
future wants on the one hand, and of the amount which the 
capital will add to his income, on the other hand, that guided 
him in the original saving which led to the purchase of the first 
reaper. 

Similar illustrations can be found in other kinds of undertak- 
ings. Many business enterprises have failed because business 
men have " lived beyond their incomes " — which often means 
simply that they have not replaced their capital so rapidly as 
they have used it up. Many American railways have main- 
tained a specious prosperity for many years by paying " un- 
earned dividends " ; that is, by letting their capital (roadbed, 
rolling stock, buildings, etc.) deteriorate through not expending 
enough of their gross income in the maintenance of their way 
and equipment. 

The stock of capital in existence at any one time is the result of 
past saving. But this stock of capital cannot be maintained intact 
without more saving. From this point of view we may say that 
the sacrifice of present satisfactions for future satisfactions 
which society undergoes in order to reap the advantages of 
capitalistic production is not something that is done " once for 
all," but is a continuous sacrifice. 

The Shifting of Investment. — As a matter of fact, a large 
amount of the capital that is used up in production is not re- 
placed, for the simple reason that entrepreneurs find that some 
particular kinds of capital are not profitable ; that is, they do 
not add enough to the selling value of the entrepreneur's total 
product to repay them for their cost (including interest and 
repayment of principal). It may happen that the entrepreneur 
has been mistaken as to the technical efficiency (or productivity) 
of his capital, or that he has overestimated the demand for his 



INTEREST 503 

products. New inventions or new methods of production may 
lessen the income-yielding power of part of the existing stock of 
capital, or capricious changes in demand may have a similar 
effect. At the same time, these new methods of production and 
these changes in demand are making new forms of capital prof- 
itable. Even if the " replacement fund " were a definite and 
rigid annual sum, it would not be entirely devoted to replacing 
the particular kinds of capital that had been used up in produc- 
tion. There would be a continual shifting from the less prof- 
itable to the more profitable forms of capital. 

We often hear it said that capital is transferred from one indus- 
try to another, or from one locality to another, or from one 
country to another. Such expressions are misleading. Capital 
goods are not usually transferred in this fashion, although in 
exceptional cases it may happen.^ These statements often 
mean that the ownership of capital changes, as when a capitalist 
sells his holdings in one industry to another capitalist and invests 
his own funds in another undertaking. The most important 
way in which " capital is transferred " is through that gradual 
process of shifting in the forms of investment which has just 
been described. 

The Relation of the Durability of Capital Goods to Invest- 
ment. — The ease with which investments may be shifted 
varies for different forms of capital. Especially important in this 
connection is the durability of capital. As has been already 
suggested, some forms of capital are destroyed as capital by a 
single use. The fuel and raw materials used in a manufacturing 
establishment and the merchant's stock in trade belong to this 
category. The merchant's stock in trade becomes consump- 
tion goods in the hands of consumers ; raw materials reappear 
in the finished product, as do other forms of capital for that 
matter, although in a less obvious sense. But the fact remains 
that these particular forms of capital investments yield their 
services only once, and when they are once used by the entre- 

1 For example, some generally used kinds of machinery (such as lathes, milling 
or planing machines, engines, or motors) may be transferred from one establishment 
in one industry to an estabhshment in another industry. 



504 OUTLINES OF ECONOMICS 

preneur for the purpose for which they were intended, they 
cease to be capital, even though they may have successors in 
new forms of capital. 

From such transient forms of capital we may pass by insensible 
gradations to capital goods which yield a long succession of serv- 
ices, the series culminating in such durable forms of capital as 
buildings used for productive purposes, or railway roadbeds. If 
a particular form of capital lasts for exactly a year — the period 
of time usually taken as a unit in the computation of the rate 
of interest — estimating the expense of employing such capital 
is a very simple matter. If, for example, the rate of interest 
which an entrepreneur sets as his minimum is 6 per cent, he will 
not invest $1000 in such capital unless he estimates that it will 
increase his product by an amount that will sell for at least 
$1060. 

In the case of the more transient forms of capital, however, the 
computation is usually made by taking into account the " rate 
of turnover." A manufacturer may be constantly buying raw 
materials and making them into finished products. If the raw 
materials purchased during a year cost $3000, but if, on the 
average, only $1000 is invested in raw materials at any one 
time, the capital is said to be " turned over " three times during 
the course of the year. The interest rate is computed only on 
the average amount of capital " tied up," so that interest of 2 
per cent on each turnover would amount to 6 per cent on the 
actual investment of money. 

In the case of the more durable forms of capital the computa- 
tion is more complicated. Here the entrepreneur has to take 
into account not only the original expense of the capital good and 
the amounts which it will add to his annual product, but also its 
durability, and the fact that a large part of the income which it 
will earn for him is future income. This future income, as we 
have seen, will not be appraised so highly as the same amount of 
present income would be. 

The Expense and Price of Capital. — When we speak of the 
cost or expense of capital, we may have in mind either one of 
two distinct things. We may mean (i) the price paid by the 



INTEREST 505 

entrepreneur for the loan of the money funds which he invests 
in specific kinds of capital goods, or we may mean (2) the prices 
paid for the capital goods themselves. The first thing is, of 
coarse, loan interest; the second is simply a matter of the 
market prices of commodities. It is this second thing — the 
market price of capital goods — that we wish to .consider at 
this point. As commodities, these capital goods come under 
the general laws of value and price, and most of what has 
been said in earlier chapters about the valuation of consump- 
tion goods holds just as true in respect to the valuation of 
these production goods. Their price at any given time is 
apt to be fixed rather close to the point where demand and 
supply would be in equilibrium. In the long run their values — 
if they are not patented products, but are competitively pro- 
duced — cannot get very far away from the expenses of produc- 
ing them. 

But there is one fundamental difference which has been sug- 
gested in other connections. Consumption goods are valued 
because they satisfy human wants, and the intensity of the 
wants which particular units of goods satisfy have, through 
the principle of marginal utility, a very direct relation to their 
market values. Capital goods do not satisfy human wants 
directly ; they command a price simply because they aid in 
the production of goods that do satisfy human wants directly. 
The demand for them, as we have seen, is the entrepreneur's 
interpretation of the demand for their products. The law of 
diminishing productivity bears about the same relation to the 
determination of their values that the law of diminishing 
utility does to the determination of the values of consumption 
goods. 

As in the case of the demand for labor, the elasticity of the 
demand for a particular sort of capital goods is affected not 
only (i) by the fact that the higher the price of the capital, 
the higher will have to be the price of the product, and, conse- 
quently, the smaller will be the quantity of the product that 
can be sold, but also (2) by the fact that when the price of any 
variety of capital goods is relatively high, the entrepreneurs 



5o6 OUTLINES OF ECONOMICS 

will economize in the use of that particular kind of capital and 
will use relatively more labor, relatively more land, and rela- 
tively more of the other forms of capital. The first of these 
facts is a corollary of the law of diminishing utility ; the second, 
a corollary of the law of diminishing productivity. 

This analysis of the price of capital goods relates, however, 
only to the supply of new capital goods. After capital goods 
are once definitely installed in industrial uses, its selling value 
is determined solely by its ability to earn an income for its 
owner. If the entrepreneur has overestimated the technical 
efficiency of a machine or the salability of its products, that is, 
if he has overestimated its income-yielding power, he may find 
that its money value to him is less than the price he paid for it. 
Here, however, we have to note an important distinction be- 
tween /ree capital and specialized capital. 

Free and Specialized Capital. — By free capital we mean 
capital that has a number of different possible uses, or that can 
be transferred from one industry or one establishment to an- 
other. Specialized capital is capital that can be used for only 
one purpose, and that cannot be transferred from one estab- 
lishment or industry to another. The capital invested in the 
construction of a railway roadbed, or in the digging of an irri- 
gation ditch, is absolutely specialized. The roadbed and the 
irrigation ditch are of use only in connection with the particular 
transportation or agricultural undertakings for which they were 
constructed. If the undertakings should fail, the value of these 
specialized forms of capital would be absolutely wiped out. A 
manufacturing firm may invest a large amount of money in 
new models of specially designed machinery. If the new 
machines prove unsuccessful, their value may sink to what they 
will sell for as scrap iron. 

Free capital is found in such forms as tools, machines of the 
standard models that are used in different establishments in 
the same industry, or even in different industries ; raw materials 
that can be made up into different kinds of finished products 
and the like. A farmer who stocks his farm with dairy cattle, 
but finds his land unsuited for a dairy farm, does not incur a 



INTEREST 507 

total loss on his investment, for he can sell his cattle to some 
farmer who can make profitable use of them. 

The distinction here emphasized is only one of degree. We 
have capital in a considerable variety of forms that are partly 
free and partly specialized. Such capital is capital that is bes-t 
adapted to one specific purpose, but which may also be put to 
other uses. One frequently sees buildings, originally erected for 
office purposes on a badly chosen site, that have been give over 
to small manufacturing concerns. A building intended for a 
factory may serve fairly well as a warehouse. 

The importance of these distinctions lies in the fact that the 
possibility of alternative uses forms a barrier to the deprecia- 
tion of the selling value of such free capital as is found to yield 
less income in some particular use than was expected by the 
entrepreneur. If such goods can yield a larger income in some 
other use, they can be transferred (through a change in the 
nature of the entrepreneur's business or through sale or lease to 
other entrepreneurs) to this more profitable use. Such trans- 
fers are continually taking place in actual business. 

Capital and Land. — The analysis of the process by which 
capital goods are priced opens the way for a consideration of a 
problem that has been suggested in earlier pages, — the rea- 
son for the economic distinction between capital and land. 
Some points of similarity are obvious : land and capital are 
both valued according to their income-yielding power. The 
selling value of land, like the selling value of capital, is based in 
large measure on the capitalization of the prospective income 
to be derived from it. From the point of view of the individ- 
ual investor, the purchase of land for productive purposes is an 
investment of money just as truly as is the purchase of capital 
goods. 

Yet there are equally obvious differences : land is given by 
nature; capital is "man-made." The amount of land is 
limited — a statement that holds true whether we have in 
mind the land actually available for productive uses under 
existing conditions, or whether we have in mind the whole 
surface of the earth. The supply of capital, on the other hand, 



5o8 OUTLINES OF ECONOMICS 

is capable of indefinite extension. It may be said, of course, 
that an extension of transport facilities, by which the available 
supply of land is increased, is a " production of land." This 
is, however, only a figurative use of the word " production." 
In this figurative sense the growth of a city, by which barren 
areas become desirable building lots or factory sites, is like- 
wise a " production of land." The recent opening up of the 
Canadian Northwest has been due to the production of capital 
in the form of railways. The land was already there, but the 
necessary form of capital was lacking. Another distinction 
is found in the fact that land, in its most essential qualities, is 
a permanent thing, while capital is of all possible degrees of 
durability. 

These obvious physical differences between land and capital 
would hardly justify us in drawing a line between them in a 
discussion of the distribution of wealth unless these physical 
differences were the causes of differences in the ways in which 
the incomes from land and capital are determined — differ- 
ences, that is, between rent and interest. Here, again, we find 
points of similarity and points of difference. The points of 
likeness become prominent when we view the mechanism of 
wealth production as it exists at any given time, but become less 
significant as we shift our view to the forces at work through a. 
considerable period of time. 

If, for example, we could take something like an instantant^us 
photograph of the processes of the production and distribution 
of wealth, we would see no important differences between the 
capital and the land used in production. We would see that 
society is equipped with a stock of capital goods, in all stages 
of wear, of all possible degrees of technical efficiency, and vary- 
ing greatly in fitness or adaptability to the work of producing 
the particular products that consumers are demanding. Not 
all of these capital goods are yielding an income that is suffi- 
cient to provide for their replacement as they wear out, and in 
addition to pay a surplus, or premium, in the form of interest. 
Some, it is true, may be yielding even more than the amount 
necessary for these purposes. Machinery of new and excep- 



INTEREST 509 

tioiially efficient sorts, but not as yet of widespread or general 
Use ; raw materials or dealers' stocks of goods that, by reason of 
a sudden increase in demand, are selling at an exceptionally 
high price, --^ such capital goods may be earning considerably 
more than interest and replacement. 

On the other hand, we would see a large amount of capital in 
such forms as obsolete kinds of machines, ill-planned factory 
buildings, raw materials or dealers' stocks in trade that were 
bought in expectation of a demand that did not materialize. 
Such capital goods may earn considerably less than interest and 
replacement. When capital is once fixed in definite forms, the 
question of the original money cost of the capital does not enter 
into the question of the profitableness of using it. An entre- 
preneur who borrows money to invest in capital goods has to 
repay the interest and ultimately the principal of the loan, 
whether this particular investment of capital proves sufficiently 
remunerative or not. In accounting practice such expenses 
are called " fixed charges," because they go on whether the cap- 
ital is used profitably or not. In fact, the entrepreneur will 
find it to his advantage to use the capital, rather than to let it 
lie idle, so long as its use adds anything to his total net income. 
A machine may thus be worth using, even if not worth replac- 
ing ; dealers can better afford to sell their goods for less than 
they paid for them than not to sell them at all ; a landlord will 
prefer to rent a building at a very low cost, rather than to let it 
remain vacant. Capital goods that are just barely worth us- 
ing may be called " marginal capital goods," and are, from our 
present viewpoint, analogous to marginal land. At any given 
time, then, the existing capital goods which it does not pay to 
use may be thought of as " below the margin," while the income 
yielded by the better capital goods may be thought of as a 
rent of capital, analogous in many ways to the rent of land. 
For this reason Professor Marshall has cahed the income from 
capital goods, when the point of view takes into account only 
a short period of time, quasi-rent. 

When, however, we shift our point of view so as to take into 
account a longer period of time, we see an important difference 



5IO OUTLINES OF ECONOMICS 

between the income from land and the income from capital. 
We see, then, that society's stock of capital is a shifting thing. 
On the one hand, it is being continually depleted on account of 
the fact that, in the process of production, capital goods are 
being used up or worn out, or because they are in some cases 
passing for other reasons below the margin of profitable use. 
On the other hand, the stock of capital is continually being 
replenished by the investment of savings in new forms of 
capital goods. Most of these investments merely replace capi- 
tal that has been worn out or used up, but some, and in a pro- 
gressive society, a considerable proportion, represent the crea- 
tion of new forms of capital. 

Now, as we have seen, the investment of savings in capital 
goods is guided by the estimates that entrepreneurs make of the 
profitableness of these investments, the criterion of the profit- 
ableness of any possible investment being its ability at least to 
replace the principal and provide for the interest on the money 
invested. When experience has shown that particular forms 
of capital will not measure up to this standard of profitableness, 
these forms will not be replaced as they wear out. When 
certain forms of capital enable entrepreneurs to get any con- 
siderable surplus over and above interest and replacement, the 
tendency will be, so far as competition rules (that is, so far as 
monopoly, as in the case of patented machinery, does not pre- 
vent), to increase the investments in these forms of capital, and 
in this way to force the earnings of these specially advantageous 
forms of capital down to the common level of interest and 
replacement. Just as the expense of producing consumption 
goods forms a " normal price," to which their actual prices 
(under competitive condition) continually tend to approxi- 
mate, so the expenses incurred in investments in capital form 
a " normal remuneration of capital,'^ toward which its actual 
earnings continually tend. Similarly, the price of capital, 
although actually determined at any one time, like the price 
of land, by its ability to earn an income for its possessor, tends 
in the long run to approximate the expense of producing capi- 
tal. This expense includes, it must be remembered, both the 



INTEREST 511 

actual money cost of new capital goods and the expense of in- 
terest on this money cost. Normal interest is the interest on 
absolutely free capital in the form of loanable junds. 

Land, of course, has no normal price, because it has no ex- 
pense, of production. This difference is not of mere theoretical 
importance, but has an important bearing upon many social 
problems. For example, when we take a long period of time 
into account, no such thing as an " unearned increment " ap- 
pears in the value of capital. Productivity has to be imputed 
to capital because its supply is limited by reason of its expenses 
of production and by reason of the sacrifices involved in wait- 
ing, while productivity is imputed to the better lands simply 
because the supply of them is limited by nature. When we 
measure rent as a return per acre (or other unit) of land, and 
interest as a percentage on the money invested, we recognize 
this fundamental distinction between rent and interest. That 
rent may be viewed for some purposes as interest on the money 
value of the land, and that interest may similarly be viewed 
(at any given time) as a " quasi-rent " of capital goods, does 
not alter the fundamental nature of the distinction. 

We have seen that the shifting of investment by which the 
earnings of capital are made to tend toward a normal standard 
is easier in the case of the more transient forms of capital 
than in the case of the more durable forms. The more durable 
a capital good, the more nearly is the income derived from it 
analogous to the rent of land. As was suggested in the discus- 
sion of rent, it is not necessary or advisable to draw a hard and 
fast line between capital and land. Permanent investments 
of capital in the form of improvements to land may very 
properly be regarded as land. The farmer who is contemplating 
installing a drainage system or an irrigation system for his 
land views such an investment, at the time, as an investment 
of capital. But when the capital is definitely incorporated 
with the land in these permanent forms, there is no reason why 
it should be called capital rather than land. The total income 
yielded by the improved acres will, in all essential particulars, 
be land rent. 



512 OUTLINES OF ECONOMICS 

The distinction which we have drawn between capital and 
land is not a mere matter of names. It makes little difference 
whether we call one group of productive agents " capital ", 
and another group " land " or whether we class all of these 
productive agents together (as many economists do) under the 
name of " capital." The important thing is that we should 
see clearly that there is one group of productive agents whose 
" rents " are determined — in the long run — by the rate of 
interest on loanable funds, and that there is another group of 
productive agents whose earnings are not so determined. 

Capital and Consumption Goods. — There are also some 
points of likeness between capital and the more durable forms 
of consumption goods. The person who buys a piano 'is not 
only satisfying his present wants, but expects to get from it a 
long period of use, extending into the future. The purchase of 
any durable consumption good is in this way one form .of sav- 
ing for the future. Moreover, such provisions for future wants 
will not be made unless we feel that present provision for these 
future wants are important enough to justify us in giving up 
some possible present satisfaction. 

These facts must be taken into account in any full analysis 
of the valuation of consumption goods, but they do not justify 
us in obliterating the line between capital and consumption 
goods. Consumption goods yield directly an income of satis- 
factions ; capital yields a money income. A merchant's stock 
in trade is capital because it will yield a money income to its 
possessor; when sold to consumers, the same goods become 
consumption goods because they yield an income of satisfac- 
tions. In short, the distinction between capital and consump- 
tion goods is based upon one of the most fundamental things 
in the existing economic system — the fact that the incomes 
which men receive for the productive services of their capital 
are money incomes. 

Capital and Wages. — In most undertakings wages are 
advanced to workmen eng^aged in the production of goods before 
the goods are sold. A farmer, for example, has to pay his 
harvest hands and other workmen before he receives any money 



INTEREST 513. 

from the sale of his wheat. Whether he borrows the amount 
needed for wages, or whether he pays them out of his own sav- 
ings, interest on the amount advanced has to be counted among 
the expenses of production, and the wages advanced are, for 
the time being, an investment of capital. In most manufactur- 
ing establishments a more or less lengthy average period of 
time elapses between the work actually done by the workmen and 
the sale of the products of their work. In such establishments 
a considerable amount of capital is invested in wage advances. 
This does not mean that we are to consider the laborers as being 
in any sense capital. For the gradual process by which the 
raw material becomes the finished product is itself a continuous 
investment of capital. All of the various expenses of production 
are really different ways of investing money in capital goods. 
Add to the cost of the raw material all of the expenses (including 
wages and payments of rent and interest as well) incurred in 
order to produce the finished product of the estabhshment, 
and you have simply the total investment in capital goods in 
the form of the finished product. A complete inventory of 
capital goods would include then (in addition to buildings, 
machinery, etc.) not only raw materials and the finished prod- 
ucts that are ready for sale to consumers, but also the prod- 
ucts on hand at any one time in a partly finished state. Thus, 
though the payment of wages is often an investment of capital, 
it must be remembered that the payment of wages is only one 
of the ways in which money is invested in concrete, definite, 
capital goods. 

Competitive Investment. — Thus far our discussion has run 
in terms of the investment of money in what we have just called 
" concrete, definite, capital goods," to be used in the produc- 
tion of other goods. We have pictured entrepreneurs and 
capitalists as servants of society, — as investing money in 
producing the things people want and are willing to pay for. 
But in order to portray some of the essential facts of modern 
business enterprise this picture has to be modified. Business 
men are primarily interested in acquisition rather than in pro- 
duction, in making money rather than in making goods. From 

2L 



514 OUTLINES OF ECONOMICS 

the point of view of both the entrepreneur and the capitalist, 
money is invested to yield an income rather than to increase the 
aggregate output of consumable goods. 

In part, and in very large part, it is true, investments yield an 
income because they further the production of things that 
satisfy human wants. Such is the case in general with (income- 
yielding) investments in agriculture and in other industries 
where the products of competing establishments cannot be 
distinguished, one from another, and are sold in a general 
market where prices are fixed very accurately by general com- 
petitive conditions. But there is left a very important field of 
enterprise in which the entrepreneur may find it worth while 
to invest large amounts of money in " selling expenses." Put 
in a very general but roughly accurate way, these expenses are 
incurred, not in producing things people want, but in inducing 
people to want the particular things the entrepreneur has for 
sale. Advertising expenditures are the most obvious form of 
such investments. Part of the salaries paid to traveling sales- 
men must also be placed under this head. Sometimes a new 
establishment will be created, with full knowledge of the fact 
that it must run at a loss until a demand for its products is 
developed. Such losses are investments of this type. Two 
thirds or more of the aggregate expenses of many establishments 
making patent medicines are selling expenses. And in the manu- 
facture and sale of other products enormous investments are 
made with the purpose of creating and holding a market for 
goods marked by particular brands and trade-marks. A note- 
worthy feature of modern business is the attempt on the part of 
manufacturers and wholesalers to influence the demand of ulti- 
mate consumers through advertising. 

From the point of view of the individual competitor such 
expenses and the expenses of buying or making capital goods 
are alike " investments." But they are competitive, acquisi- 
tive, investments rather than socially productive investments. 
Their purpose is not to satisfy an existing demand but to shift 
demand from other channels. So far as such expenditures 
succeed in gaining trade, the capitalized income-yielding power 



INTEREST 515 

of a business undertaking will be greater than the " capital 
values " that can be imputed to the stock of capital goods on 
hand. These surplus capital values, embodied only in the 
preferences of consumers for particular products, may be 
recorded, hke other values, in the actual price paid when the 
business is sold. 

This is not to say that all selling expenses are from the social 
point of view wasteful. Some of the things for which a mar- 
ket is thus created may be better things, judged by rational 
standards, than the things which they displace. Moreover, 
scrupulously truthful advertising is frequently a real help to 
the consumer, perplexed by the range of alternative choices 
open to him, and often without knowledge of the qualities of 
competing goods or of their fitness to serve his purposes. But 
this is only an incidental and by no means a necessary result of 
these competitive investments. They may sometimes lead to 
the education of the consumer, but they may also lead to the 
exploitation of weakness and ignorance. And in either case they 
are no part of the social process of the " production of goods." 

The Flow of Money Income. — We now come to the heart of 
our problem, — • the analysis of the general forces determining 
the rate of interest. For this purpose we shall find it conven- 
ient to examine the general process of the flow of money ^ 
income. There is a continuous flow of money income through 
the hands of entrepreneurs, appearing first in the form of the 
prices that are paid them for their goods, then (neglecting 
profits) in their own payments for labor, land, and capital, 
then reappearing in the prices which those who furnish these 
agents in production pay for other goods, and so on in a con- 
tinually recurring cycle of income and outgo. 

This process is made more complicated, however, by the fact 
that not all of the entrepreneur's expenses appear directly as 
rent, wages, or interest. A considerable part, and in many 
cases (as in mercantile establishments), the largest part of such 
expenditures is for various concrete forms of capital, — raw 

1 Using the word money in its broadest sense, including such transferable credit 
instruments as are used in making payments. 



5l6 OUTLINES OF ECONOMICS 

materials, dealer's stocks of goods, machines, etc., — and for 
advertising as well. Here a part of the money income received 
by the entrepreneur in the form of the prices paid for his own 
goods emerges in the prices which he pays for the goods sold by 
other entrepreneurs, and which, in turn, make up a part of their 
money incomes. But this other class of entrepreneurs — who 
supply capital goods rather than consumption goods — are 
subject to the same necessity of expending their money incomes 
in the payment of wages, rent, and interest, and in the purchase 
of different kinds of capital goods. To push the analysis still 
further would obviously lead us only into needless repetition. 
One important fact, however, appears clearly: If we could 
trace the expense of producing any consumption good back 
through all the long series of services and of production goods 
that have contributed to its making we would find that this 
expense reduces itself, ultimately, to rent, wages, and interest, not 
counting what remains in the entrepreneur's hands as profits. 
Part of the flow of money income passes through the hands of a 
chain of entrepreneurs, but it nevertheless originates in the 
prices that consumers pay for the things that satisfy their 
wants and emerges in the form of the payments made for the 
productive services of land, labor, and capital. 

Yet another correction must be made, however, to fit this 
picture of part of the economic process more closely to the facts. 
The money which consumers pay for particular commodities 
does not usually constitute the actual fund with which the 
entrepreneur pays for the labor, the land, and the capital goods 
used in the production of those particular commodities. Still 
less does it constitute the actual fund from which the entre- 
preneurs who supply the necessary capital goods pay their 
expenses, or from which the expenses of still more remote stages 
in the process of production are paid. The roimdabout, in- 
direct methods which characterize modern production, and 
which involve the division of the productive process among 
countless different undertakings, take time. The goods which 
consumers buy today are the result of a long series of produc- 
tive efforts extending back indefinitely into the past. Simi- 



INTEREST 517 

larly the productive efforts of today avail but relatively little 
toward the satisfaction of present wants, for they are in large 
part directed to forwarding, often in the most indirect ways, 
the production of things that will come to a final fruition in the 
satisfaction of human wants only in the more or less remote 
future. 

The Annual Product and the Social Dividend. — Viewed in 
this way the annual product of society is something very differ- 
ent from the social dividend. The year's work is begun with an 
equipment of econohiic goods of all kinds, — finished goods in 
the hands of dealers and manufacturers, goods in all stages of 
completion, growing crops, factory and mercantile buildings, 
machines, and all the auxiliary apparatus of production in a 
finished or unfinished state. The annual product includes all 
the additions made to this stock of goods, and all that is accom- 
plished in forwarding such goods as are destined for human 
consumption towards the form, place, and time in which and 
at which they are wanted. It includes all that is done in a 
similar way to forward, replenish, and increase the stock of 
production goods. It includes also all the personal services 
that command a money payment which are not embodied in 
concrete goods, but which confer their benefits in the very in- 
stance of their performance. 

But while the productive efforts of society are thus constantly 
building up and modifying the stock of economic goods, this 
stock is continually being depleted in various ways. The 
instruments of production are constantly wearing out, or are 
being cast aside on account of the introduction of either more 
efficient appliances or more efficient methods which utilize 
other kinds of appliances. Then, too, as the final outcome of 
this productive process there is a constant stream of finished 
consumption goods passing into the hands of consumers. The 
social dividend consists of this flow of consumption goods, to- 
gether with those direct personal services which do not have to 
do directly or indirectly with the fitting of goods for human, 
consumption, but which nevertheless satisfy wants and com- 
mand a money payment. While the social dividend is to a 



5l8 OUTLINES OF ECONOMICS 

large extent the outcome of past work and effort, the annual 
product is very largely a provision for future wants. 

What is the effect of all these considerations upon our analysis 
of the flow of money income? It still remains true that the 
money which consumers pay to entrepreneurs is in turn used 
by them in the payment of their expenses of production, and 
that the money which they in turn pay to other entrepreneurs 
for various forms of capital goods is used in the payment of 
expenses of production. But the prices consumers are paying 
are for goods, the expenses of producing which have (at least in 
greater part) already been paid. If we should trace back the 
expenses of producing the capital goods used in producing these 
consumption goods our search would lead us into the more 
remote past, while still further analysis of the expenses of pro- 
duction would discover an increasing number of ramifications 
running back into the still more distant past. The present 
flow of money income, originating in the prices paid by con- 
sumers, passes, as we have seen, through the hands of a chain 
of entrepreneurs and in this process gets ultimately into the 
hands of laborers, capitalists, and landlords. But most of the 
productive services which are thus remunerated are services 
which will avail toward the satisfaction of future rather than of 
present wants. In other words, the prices paid for consumers' 
shares in the social dividend constitute (save for an important 
exception to be noted presently) the fund which pays for the 
annual product. The productive ej^orts of the past, which satisfy 
the wants of today, were paid for out of past income, while the 
present work of producing goods that will he ripe for consumption 
only in the future is paid for out of present income. In this fact 
lies the kernel of the interest problem. 

Investment a Cumulative Process. — Not only, as we have 
seen, does the entrepreneur invest in such things as machines 
and buildings, but his purchases of raw materials, his advances 
of wages to laborers, the interest which he pays on borrowed 
capital, the rent or the purchase price which he pays for 
land, and his various competitive selling expenses are also in- 
vestments. No such investments can be regarded as remu- 



INTEREST 519 

nerative unless the entrepreneur gets in the selling prices of his 
products enough to provide interest upon such outlays as well as 
to cover the outlays themselves. These facts have already 
been noted, but at first, for simplicity's sake, we confined our 
analysis to the capital expenditures of the individual entre- 
preneur. The full significance of the role which capital plays in 
production does not appear until we view the activities of the 
individual entrepeneur as only a link in the continuous chain of 
activities that make up the productive process. 

The point of special significance in this connection is the fact 
that the finished products sold by some entrepreneurs constitute 
the capital goods (raw materials, productive apphances, adver- 
tising media, etc.) bought by other entrepreneurs. When one 
entrepreneur sells his products to another entrepreneur his 
period of " waiting " is completed, so far as his advances of 
money funds in the production of these particular units of goods 
are concerned. But the '' waiting " is only transferred to the 
other entrepreneur, who adds further expenditures of money 
and, in turn, gets his remuneration from the sale of his product. 
The important conclusion to which this analysis leads is that 
(so far as the entrepreneurs have been accurate in their esti- 
mates) the prices which consumers are paying today for finished 
goods cover not only all the actual money expenditures which 
have been made in the past in the production of these goods, 
but also the interest on all such expenditures from the time 
they were made up to the time of the sale of the finished goods 
to the ultimate consumer. 

Similarly the expenditures made by entrepreneurs today in 
the production of goods that will directly or indirectly satisfy 
future wants must (so far as these entrepreneurs and those who 
will control the remaining steps in the productive process are 
accurate in their estimates) be covered, together with accrued 
interest, by the prices which consumers will pay in the future. 
Present wants are satisfied by means of the productive efforts of 
the past. These productive efforts were paid for out of past 
income, but the outlays were made in the expectation that pres- 
ent prices would suffice to repay them, with interest. A par- 



520 OUTLINES OF ECONOMICS 

ticular entrepreneur may be interested only in disposing of his 
products at remunerative prices to the entrepreneurs who stand 
next to him in the productive series, but tliis does not alter the 
essential nature of investment, which, from the social point of 
view, is a cumulative process. 

The Sources of Investment Funds. ^- The gross money in- 
come of entrepreneurs furnishes by far the most important part 
of the current supply of investment funds, and the most im- 
portant form of investment is found in the entrepreneur's 
customary practice of " putting money back into the business." 
That this way of investing money is customary, even habitual, 
does not mean that the amount as well as the particular forms 
of such investments is not a matter subject to the discretion 
of the entrepreneur. So far as the entrepreneur is not hampered 
by contracts (with customers, other entrepreneurs, money 
lenders, landlords, or laborers) he is free to do as he pleases 
with his income. As a matter of fact he is likely to devote a 
fairly constant proportion of it to the replacement of the capital 
goods that are being used up or worn out and to the other 
necessary expenses of continued production. 

It rarely happens, however, in any undertaking, that income 
and expenditure are so nicely adjusted and so evenly distributed 
through the year that the one always suffices to provide for the 
other. A temporary surplus may be followed by a temporary 
deficit. Transfers of goods on credit, helped out by the institu- 
tion of banking, smooth over some of these irregularities. More- 
over, while the entrepreneur need not continue to renew his 
capital investments unless he chooses, he is at liberty to do even 
more than this if he deems it advisable. That is, his profits — 
the excess of his gross income over and above his current and 
normal capital expenditures — ■ may be used for additional capital 
expenditures. 

Still another source of capital funds is found in the rent, wages, 
and interest into which, as we have seen, the expenses of produc- 
tion ultimately resolve themselves. For so far as these forms of 
income are saved by their recipients, rather than expended im- 
mediately for consumption goods, they may be lent directly or 



INTEREST . 521 

through savings institutions to entrepreneurs. This is the 
important exception, previously mentioned, to the statement 
that " the prices paid for consumers' shares in the social dividend 
constitute the fund which pays for the annual product." The 
truth is that as the flow of money income passes from entre- 
preneur to entrepreneur, a part only, although the larger part, is 
put into expenditures for gain. The residuum is used by entre- 
preneurs in paying for their own shares in the social dividend. 
In much the same way the money income received by those who 
furnish labor, land, or capital is only in part paid back to entre- 
preneurs in return for consumption goods, the residuum being 
put (through loans to entrepreneurs) into expenditures for gain. 
The Interest Rate. — It will be seen, then, that as the flow 
of money income passes through the hands of entrepreneurs, 
laborers, capitalists, and landowners, it is divided into two 
streams, one of which goes to pay for the present goods that have 
been produced in the past, while the other goes to pay for the 
present expenses of forwarding the production of goods for future 
consumption. This division represents a kind of social balanc- 
ing of possible present satisfactions over against the larger future 
satisfactions which the productive use of capital makes possible. 
On the one hand we have the entrepreneurs' estimates of how 
much specific amounts of capital funds are worth to them, — 
estimates which involve judgments as to the amount of salable 
product dependent upon the use of these specific amounts of 
capital funds, the prices that can be got for such products, and 
the period of time that will elapse before they will be remuner- 
ated for such investments. On the other hand we have the 
judgments of those who supply capital funds as to the relative 
importance of future and present satisfactions. The interest 
rate will normally be fixed, of course, at a point where the supply 
and demand of money funds for investment will be in equi- 
librium.^ 

1 Short-time fluctuations in the interest rate are dependent very largely on the 
condition of bank reserves. This relation has been explained in the chapters on 
money and banking. In the long run, however, it is the " supply of waiting " that 
is the important thing. 



522 OUTLINES OF ECONOMICS 

The process of production involves the expenditure of rent, 
wages, and interest for returns of all possible degrees of futurity, 
and a consequent comparison and balancing of the productivity 
of investments for shorter and longer periods of time. That is, 
social estimates ^ of productivity are estimates of the relative 
importance of the ultimate products, realizable at different 
periods of time in the future, that are dependent upon specific 
present expenditures in the form of rent, wages, or interest. 
Or, in other words, there is a continuous effort to make the most 
advantageous of all the various possible combinations of land, labor, 
and waiting. For just as rent, wages, and interest are the 
ultimate expenses of production, so the ultimate factors in 
production may be said to be land, labor, and waiting. 

The entrepreneur bases his demand for investment funds 
upon his estimate of the demand for his products, together with 
his estimate of the relative economy of the use of methods call- 
ing for greater or less degrees of " roundaboutness," involving 
different amounts of waiting on the part of himself and of 
others who supply him with investment funds. This means 
that the interest rate is itself one of the factors determining 
the demand for waiting. The higher the rate of interest, the 
greater will be the expense of using roundabout methods, in- 
volving much waiting. 

The supply of waiting varies with the interest rate. Other 
things being equal, the higher the interest rate, the larger will be 
the parts of money incomes that will be saved rather than spent 
immediately in the satisfaction of wants. It has sometimes been 
said that saving increases as wealth increases. If this is taken to 
mean that the larger the income of the individual, the larger, 
other things being equal, will be the amount he will save, the 
statement probably expresses a general truth. The larger the 
income, the less important are the immediate wants dependent 
for their satisfaction on a given amount of money. It does not 
follow that the proportion of the income that is saved is apt to be 

1 By " social estimates" of productivity we mean only the net outcome of the indi- 
vidual estimates of all the difierent individual buyers and sellers, lenders and 
borrowers. 



INTEREST 523 

any larger in the case of a large income than a small income. 
If, on the other hand, the statement is taken to refer to the in- 
crease of wealth in society at large, we have to take account of 
the fact that as wealth increases new wants develop, and the net 
effect on saving is apt to depend on the character of the new 
wants, — whether they call for increased current expenditures or 
whether they involve the accumulation of considerable sums. 
Convenient opportunities for saving, such as those afforded by 
savings banks, insurance companies, and the supply of con- 
venient forms of investment securities have (apart from the rate 
of interest they offer) an important effect upon the amount of 
saving. 

Gross Interest and Net Interest. — Net interest is pure inter- 
est — the amount actually necessary to recompense marginal 
waiting. Gross interest — the interest actually paid on loans 
— ^ includes payments for other things. In the first place, 
actual interest often includes some payment for the supervision 
which the capitalist has to maintain over his investment. Even 
the man who " lives on his income " usually has to devote a 
certain amount of time to the investigation of the safety of 
different possible investments, to the collection of interest and 
principal and similar things. The net earnings of savings 
banks — the difference between the interest they get on their 
investments and the interest they pay their depositors — ^are 
partly a payment for this element of supervision. 

A second element in gross interest is the payment for the risk 
the lender undergoes of losing all or part of his expected return 
(including principal and interest). This does not mean, as some 
writers have said, that the interest rate contains an element of 
insurance, for insurance means the eUmination of individual risk 
through the combination of risks. The fact is simply that, as 
every one knows, lenders will not take greater risks without the- 
prospect of greater gains. There is some element of speculation 
in all loans but the very safest, and the extra income received on 
the more legitimate loans is profit rather than insurance. 

Usury Laws. — Interest is one form of price in regard to which 
society still expresses some distrust of the operation of un- 



524 OUTLINES OF ECONOMICS 

hindered competitive forces. Only nine American states do not 
provide a legal maximum above which the interest rate cannot 
legally be fixed. Such laws are based on the justifiable assump- 
tion that the borrower is in many cases the weaker bargainer, 
pressed often by that necessity which " never drove a good 
bargain." In many places the laws are not enforced, but else- 
where they have an important effect on some kinds of loans, 
especially bank loans in the rural districts, — • farm mortgages 
and overdue book credits. It is to be feared, however, that their 
result is often not so much to lower the rate of interest as to cut 
off many loans which lenders would not be justified in making 
except at high rates of interest. In the case of many loans on 
fairly good security, however, usury laws have probably operated 
to the advantage of the borrowers. 

QUESTIONS 

1. Could a socialist state dispense with interest? with waiting? 

2. How has the rate of interest been affected by the opening up of new 
and fertile lands? 

3. Use supply and demand curves to illustrate the determination of the 
rate of interest. 

4. Is a rented house capital or a consumption good ? 

5. Analyze the effect of an increase of expenditures for present goods 
upon present and future social dividends. 

6. If money wages could be suddenly increased by 10 per cent would 
there be a corresponding increase in real wages ? 

7. Are the roulette tables at Monte Carlo capital? Is a burglar's jimmy 
capital? Is a battleship capital? 

REFERENCES 

Bohm-Bawerk, E. von. Capital and Interest; Positive Theory of Capital, 

Books v-vii. 
Carver, T. N. The Distribution of Wealth, Chap. vi. 
^Cassell, G. The Nature and Necessity of Interest. 
Davenport, H. J. Economics of ErUer prise, Chaps, xviii-xxi. 
Fisher, Irving. Capital and Income; The Rate of Interest. 
Conner, E. C. K. Interest and Saving. 
Marshall, Alfred. Principles of Economics, 6th ed.. Vol. i. Book ii, 

Chap, iv; Book iv, Chap, vii; Book vi, Chap. vi. 
Taussig, F. W. Principles of Economics, Vol. ii, Chaps, xxxviii-xl. 



CHAPTER XXV 
PROFITS 

The difference between the total money income which an 
entrepreneur receives and his expenses of production consti- 
tutes his profits. Profits, then, are a surplus over and above 
the expenses of production. There are two ways of measuring 
profits : first, with reference to some unit of time, such as a 
year ; and, second, with reference to particular units of product. 
Thus, when a manufacturer speaks of his profits during a year, 
he has in mind the difference between his total expenditures and 
total receipts for that year. But when he speaks of his profits 
on a particular sale, he has in mind the difference between the 
expense of producing and selling the particular goods sold and 
the prices received for them. The two ways of measuring 
profits are not alike, because a large part of the expenses in- 
curred by an entrepreneur in any given year may be payments 
for work done in connection with the production of goods that 
will not be marketed until some time later. In the long run, 
however, the amount of annual profits will be determined by 
the profits on particular transactions or on particular products, 
so that for present purposes it is not necessary to press the dis- 
tinction any farther. It is sometimes more convenient to use 
the word " profits " in one sense, and sometimes in the other 
sense. 

Profits, being a surplus, do not constitute a homogeneous 
income determined by any one principle or set of principles. 
They are the resultant of all the forces that tend to bring about 
inequalities between the prices paid for things and the expenses 
of producing them. It is not possible in a brief analysis even 
to attempt to break up this mixed form of income into all of 

S2S 



526 OUTLINES OF ECONOMICS 

its constituent parts. But we must distinguish between two 
different elements in what are commonly called profits, namely 
entrepreneur^ s wage and pure profits. 

Entrepreneur's Wage. — This element in profits is sometimes 
called the " wages of management," and constitutes the pay- 
ment received by the entrepreneur for his services as manager 
or supervisor of his business. It is not easy to draw a line be- 
tween this element in profits and wages. In fact, " entrepre- 
neur's wage" could be discussed just as appropriately under 
the general head of wages as in connection with the general 
subject of profits. The only distinguishing things about this 
particular kind of wages are that, unless the entrepreneur 
adopts the bookkeeping form of paying wages to himself, they 
come out of the general surplus or residuum commonly called 
profits in actual business, and that they are the wages paid for 
a particular kind of labor. 

The average American farmer usually does a certain amount 
of work himself that might be done by hired laborers, and so 
far as his income represents the amount he saves by doing such 
work himself, it is to be regarded as ordinary wages. But in 
addition, he does other work of a more purely managerial 
quality, including the general direction of the time and methods 
of tillage and harvesting, the organization of the working force ; 
in fact, the determination of what may be succinctly described 
as the general coordination of labor, capital, and land. The 
reader may ask: Could not this part of the work be turned 
over to a salaried foreman? Certainly, and in some cases, 
as on the estates of so-called '' gentlemen farmers," all of it. 
In fact, the amount of the managerial work actually done by 
the entrepreneur himself in any kind of undertaking is a variable 
quantity, depending upon the extent to which managerial 
authority is delegated to foremen, superintendents, and salaried 
managers. In the case of corporations practically all of the 
actual work of management is intrusted to officials and em- 
ployees whose salaries are counted among the expenses of 
operation. In any case the " wages of management " exist, 
although they do not always exist as " entrepreneur's wage," 



PROFITS 527 

nor do they always constitute a part of what is called profits 
in the accounting of the enterprise. 

Even in cases where the entrepreneur is in all respects his own 
manager (which is, after all, the most frequent case in a host of 
small business undertakings), the entrepreneur's wage con- 
stitutes a kind of minimum profits, and is in reality a part of 
the expenses of production. Minimum profits are necessary 
profits, the money price needed to induce the entrepreneur to 
engage in and continue his work. They can be measured 
roughly by the salary which the entrepreneur could get by 
working for some one else. Some men would prefer to be 
their own masters even at a smaller income, while others would 
shrink from the responsibilities of independent business life, 
even if a larger income were attached to it, so this method of 
measuring minimum profits is only approximate. 

Minimum profits will vary with managerial efi&ciency. The 
more efiicient farmer will get a larger product with a given 
equipment of land, labor, and capital than will the less efiicient 
farmer. So will the more efiicient manufacturer. Differences 
in managerial efficiency wiU cause corresponding differences 
in minimum profits. 

Pure Profits Impossible under Certain Conditions. — It will 
help us to get a notion of the meaning of pure profits and of the 
sources from which they are obtained if we pause to consider 
the conditions under which they could not exist. Under what 
conditions would the selling prices of goods always be just 
about equal to the expenses of producing them (including the 
wages of management)? Under what conditions, in other 
words, would market prices always be kept approximately 
equal to normal prices? 

The first prerequisite, it is clear, is a very complete and 
perfect state of competition. Capital and labor would have 
to be so flujd that they could be shifted from one employment 
to another to take advantage of the slightest possible differences 
in gains. In the second place, it is not sufficient that business 
men, capitalists, and laborers should be quick to take advan- 
tage of their opportunities; they would have to know their 



528 OUTLINES OF ECONOMICS 

opportunities. Full knowledge of the relative advantages of 
different occupations, of different employments, of different 
investment opportunities, of different fields for business enter- 
prise, would always have to exist. Consumers, too, would have 
to be always alert to take advantage of any slight differences 
in the prices of competing producers, or in the quality of their 
goods and services. Moreover, their tastes and preferences 
with regard to the things they consume would have to be 
constant, or at most could change but slowly. Similarly, the 
introduction of new inventions and other new ways of produc- 
ing things must be ruled out. 

In short, if economic activity were sheer routine; if each 
business man, hard pressed by an alert and well-informed 
competition, had no opportunity before him except to produce 
standardized products for a dependable market, pure profits 
would be quite impossible. The able business man could get a 
larger income than his fellows only by getting a larger product 
for a given expense for labor, capital, and land. Paying the 
same prices for these productive agents as his competitors, 
selling the same kinds of products at prices identical with theirs, 
only as he gets a larger product for a given expense, only, that 
is, as he is a more e£&cient manager, can his gains be larger than 
theirs. His profits are limited to his wages of management. 
So smoothly and perfectly would the routine of the economic 
process operate that there would be no field for what is, in 
reality, merely another name for profit seeking, — business 
enterprise. 

The Sources of Pure Profits. — Pure profits exist because 
competition does not work perfectly ; because people do not 
always know and are not always alert to seize the most ad- 
vantageous course open to them either as producers or as con- 
sumers ; because there are such things as fads and fashions and 
changes in the quantity and quality of wants; because the 
system of competitive prices is not a thoroughly consistent 
structure ; because, in short, room is left for business enterprise. 

Take, for example, a very simple case. A owns a house, 
which he is willing to sell for $5000. B is willing to pay $6000 



PROFITS 529 

for just such a house, but neither A nor B knows the other or 
the other's position as a buyer or seller. C, knowing the situa- 
tion, buys from A for $5000 and sells to B for $6000, gaining a 
profit of $1000 for himself. This profit, it is obvious, is made 
possible only by the lack of complete knowledge of the situation 
on the part of A and B. The transaction is without risk to C, 
who merely takes advantage of this specific instance of the 
general fact that for many classes of goods competition fails to 
set a definite market price. 

Next, assume that the purchaser, B, has bought the house 
merely for the sake of selling it again,' if possible, at a profit. 
He may have reason to believe that there will be an increase in 
the demand for houses or in the expense of building them, so 
that he counts on finding a buyer who will pay more than 
$6000 for the house. If he succeeds, it will be because the 
general market situation, so far as houses are concerned, will 
have changed in accordance with his own forecasts. He takes 
the risk of loss, but this does not mean that he is blindly " tak- 
ing a chance." On the basis of present facts he reaches certain 
conclusions or judgments with respect to future probabilities. 
He cannot eliminate risk, but can select what seems to him to 
be a favorable opportunity. His profits — if he gets them — 
are to him the result of successful risk-taking. 

These two methods of getting profits, employed by C and B, 
respectively, indicate the two general sources of profits: (i) in-^ 
consistencies, incomplete adjustments, in the general price 
situation as it exists at any one time ; (2) changes in the general 
price situation. But (3) in most business operations these two 
sources of profits are blended. And yet there are many trans- 
actions which are like those suggested in our illustration in that 
profits are derived entirely from one source or from the other. 

I. We shall consider first those transactions in which buying 
at one price and selling at another are for the profit-seeker 
practically simultaneous operations. Risk, on the individual 
transaction, is eliminated. But there remains the risk that, if 
one makes this type of profit-seeking one's vocation, one's 
aggregate gains may not amount to enough to compensate 

2M. 



530 OUTLINES OF ECONOMICS 

one for one's incidental expenses and for the use of one's 
time. 

Profits of this kind are found in many real estate operations, 
in some transactions conducted by brokers in different fields, 
in arbitrage transactions in foreign exchange or securities or 
produce, and, naturally, in a large variety of miscellaneous 
isolated transactions. There is no reason to believe that the 
aggregate amount of pure profits of this sort is large. Where 
large margins may exist between buying and selling prices 
(as in the case of land, works of art, and other non-reproducible 
goods) or where the aggregate volume of transactions is so 
great as to make even small differences in prices significant, 
intermediaries and go-betweens multiply, and competition 
tends to pull their (annual) profits down to an entrepreneur's 
wage, or less. 

2. More important as an independent source of. profits is the 
difference between the price situation at any one time and the 
price situation at some later time. A very common profit- 
seeking operation consists of buying things now in the hope of 
selling them at a higher price, in the future, or of selling things 
now (for future delivery) with the expectation of securing them 
at a lower price in the future. The larger part of " specula- 
tion " in real estate, in produce, and in securities, is profit- 
seeking of precisely this type. 

Risk always attends such operations. The speculator may 
prove to have been mistaken in his analysis of the general 
situation, or new and unforeseen factors may enter. Prices 
may move in a direction opposite to that on which the speculator 
had counted, and losses rather than profits may result. This 
may, for example, be caused by competition in profit-seeking. 
Other speculators will in most cases have seen the same op- 
portunity for profits. By buying now in large quantities for 
speculative purposes they are sure to increase present prices. 
Similarly, by selling at a later date they are equally certain to 
make prices then lower than they otherwise would have been. 
The chief economic service of speculation, in fact, lies in its 
tendency to lessen fluctuations in prices. But the thing may 



PROFITS 531 

be overdone : future prices may be forced down to a point 
where the expected profits are turned into losses. And, mutatis 
mutandis, the same considerations hold true of " bear " opera- 
tions, on the other side of the market. The possibility of being 
caught in a price movement of this sort, resulting from over- 
speculation, is one of the ordinary risks of this kind of profit- 
seeking. 

3. In most cases, as we have said, the two general sources of 
profits are blended. The great mass of business transactions 
are not so simple as those we have just considered. Profits 
are sought, not merely by buying one thing and then selling 
it, either immediately or at some other time, but also, and 
more generally, by buying certain things and then using them, 
combimng them, in such a way as to get a new salable product, 
or at least a product to which new qualities have been added. 
Returning to the illustration of the house, we may assume that 
it may have been built to sell, and the things bought were, in 
the first instance, labor, building materials, and advances of 
funds with which to make payments. Or the house might have 
been built by a contractor, who first sold the house (for " future 
delivery ") and then bought the labor and material and advances 
necessary for its construction. And so in agriculture, manu- 
factures, and commerce generally : the entrepreneur buys some 
things — labor, land or its use, capital goods in various forms, 
advances of loanable funds — and sells other things — the 
commodities or services that are his " products." 

The inconsistencies and maladjustments in the general price 
situation of which he tries to take advantage are, in short, the 
differences between the prices he has to pay for the things he 
uses in making and selhng his products and the prices he gets 
for his products. If competition worked with absolute prompt- 
ness, smoothness, and efficiency, things would sell at prices 
equal to their expenses of production, and the most the entre- 
preneur could get would be, as we have seen, his entrepreneur's 
wage. 

The time element, involving the possibility of gains (or losses) 
from price changes, also enters in, because most of the expenses 



532 OUTLINES OF ECONOMICS . . 

of production are incurred either before or (in the case of con- 
tracts for future dehvery) after the price which can be got for 
the product is finally determined.^ 

Marginal Productivity and Profits. — ■ In our discussion of the 
law of diminishing productivity ^ we took no account of pure 
profits. We saw that in any undertaking a definite part of 
the product had to be imputed or attributed to each productive 
agent, and further, that the amount of product so attributed to 
any unit of a productive agent was the amount dependent upon 
the use of that particular unit. But this does not mean that in 
any undertaking the sum of those parts of the product which 
have to be imputed to particular productive agents will exhaust 
the whole product. Moreover, it is not wholly correct to 
think of the product as being created by the " application " of 
labor and capital to land or of land and capital to labor. 

In any business undertaking, the one thing always given or 
fixed (at any one time) is the general object of the undertaking, 
the business scheme, the productive or acquisitive plan of the 
entrepreneur. In carrying out his plans, in securing a product 
and a market for it, the entrepreneur has to utilize productive 
agents. In combining them, in applying them to his general 
profit-seeking plan, he encounters the law of diminishing produc- 
tivity, and, normally, pushes each particular kind of expenditure 
up to the marginal point. If he is successful there will be a 
surplus over and above his aggregate expenses. That is, his 
total product will more than cover -the "specific products" 
that have to be imputed to the various productive agents he 
utilizes. This surplus, of course, is his profits.^ 

1 Entrepreneurs are often able to eliminate or shift part of this price-fluctuation 
element in profits (with its accompanying chance of loss). The building contractor 
may, for example, contract for his materials when he enters into a contract to build' 
a house. Manufacturers of flour and of raw cotton, as well as grain and cotton 
buyers, are able largely to shift the risk of price fluctuations to professional specula- 
tors by means of the process known as "hedging," which will be described in Chapter 
xxix. 

^ See Chapter xix. 

' Although the present chapter is concerned only with profits in competitive 
undertakings, this analysis of the relation of profits to the law of marginal produc- 
tivity holds true also of monopoly profits. 



PROFITS 533 

Profits for the Industry and Profits for the Establishment. — 
We must note at this point an important difference between 
the production of standardized goods — where one establish- 
ment's product is hke another's — ■ and the production of goods 
or services which are marked off or distinguished as the output 
of particular establishments. 

In agriculture, for example, standardized products are pro- 
duced for a general market. If certain farmers make larger 
incomes than their neighbors it is generally because they are 
more efi&cient farmers and earn a larger entrepreneur's wage. 
This may show itself in two ways. First, a good farmer will 
get a larger product with a given expenditure. He will appor- 
tion and use his productive agents to better advantage. Sec- 
ond, because he gets a larger product by means of a given 
expenditure, he will be able to push his expenditures further 
before coming to the margin beyond which it will not pay him 
to go. That is, he can advantageously " farm on a larger 
scale " than his less efficient neighbors. But while these ad- 
vantages increase his entrepreneur's wage, they do not, in 
themselves, create pure profits. 

If the farmer gets pure profits it is because he has successfully 
tried some new crops or some new methods, or because he has 
been individually fortunate in some other way, or because 
he and other farmers have been able to sell their crops at 
profitable prices. This last point is the important one. In 
agriculture and other industries producing standardized prod- 
ucts for a general market, by far the most important profits 
(and losses) are those which come to the industry as a whole. 
Except for the effect of such things as local droughts or frosts 
or blights, when the wheat growers of the country prosper they 
prosper together, and when they lose they lose together, — 
and so with the corn growers and the tobacco growers and the 
cotton growers. Wars, tariffs, crop failures abroad, — these 
and other things like these will affect the demand for their 
products. The supply will depend in part upon weather con- 
ditions, but more largely upon the amount of these crops that 
farmers as a group have thought it worth while to plan to grow. 



534 OUTLINES OF ECONOMICS 

These conditions of supply and demand are absolutely beyond the 
control of any one individual producer. A succession of profit- 
able years is sure to result in an increased output, with lower 
prices and lower profits. In agriculture, as everywhere, there 
are rewards for the efficient and energetic producer, but, with 
minor exceptions, his chances of getting pure profits are de- 
pendent upon the fortunes of the industry as a whole. 

In the fields in which each entrepreneur can mark off his 
product or his establishment as his own, we find a very different 
situation. The manufacturer or jobber who can in sQme way 
identify his products by special brands, and the retailer, deal- 
ing directly with the consumer, are able to secure pure profits 
(and to run the risk of corresponding losses) on their individual 
undertakings, over and beyond such profits and losses as may 
come from general business fluctuations. 

Here also the entrepreneur is limited by the law of diminish- 
ing productivity, and here also he normally pushes his expen- 
ditures of all kinds up to the margin. And (if he is his own 
manager) he will get a larger or smaller entrepreneur's wage 
according as he can get a larger or smaller product per unit of 
expense. But many of his expenses will be what we have 
called " competitive investments," that is, they will be devoted 
to creating a market for his products rather than to creating 
the products. The quantities that he can profitably produce 
and, within limits, the prices he can charge, will be determined 
very largely by his success ,in inducing purchasers to prefer 
his goods or his store to others. The profits of cotton growers 
are directly conditioned, as we have seen, by the aggregate 
demand for cotton and the aggregate supply of cotton. But 
with the retail dealer and with the manufacturer of breakfast 
foods or canned fruits or clothes or soap or motor cars or foun- 
tain pens or almost any other kind of branded merchandise, 
profits depend very largely upon the preference of consumers 
for one store or for one make of goods. The getting of profits 
is not merely a matter of indirect competition among indus- 
tries; it is a matter of direct competition among individual 
establishments. One competitor may gain while others in the 



PROFITS 535 

same field are losing, and may gain even in the face of a gener- 
ally unprosperous condition of business. 

Good- will. — It very often happens that the entrepreneur 
who has developed his business to a profitable point is able to 
attach some degree of permanency to his profits. A merchant 
often relies to a very considerable extent upon the patronage 
of an established clientele of customers, and he in turn may 
prefer, other things being equal, to purchase his goods from 
particular wholesale houses. Manufacturers and wholesalers, 
too, try to build up a habitual preferential demand for their 
products. When a business undertaking is sold as a whole, 
its established connections of this sort enter into the price paid 
for it, under the head of " good-will." This good-will element 
is generally measured by the difference between the selling value 
of the business as a whole and the selling value imputed or 
ascribed to its specific assets in the form of capital goods and 
accounts receivable (minus its specific liabihties). In the sale 
of a newspaper it often happens that its good-will (its established 
advertising and subscription patronage) is the only thing ac- 
tually transferred. This does not mean, however, that the 
selling price of the good-will of an establishment necessarily 
corresponds to a capitalization of its pure profits. The good- 
will may be, in individual cases, very much less than the aggre- 
gate amount of the expenses incurred in the past in the effort 
to build it up. And when once sold at a fair price, the purchaser 
acquires no peculiar power of getting unusual profits. For him 
the price paid for good-will is an investment, and he has to 
deduct interest on the investment before he can count his in- 
come as profits. In short, he has to start afresh, with no 
differential advantage. 

Good- will is to be attributed, in large measure, to the economic 
inertia and friction which result from the fact that buyers are 
guided to a very large extent by custom and habit rather than by 
conscious choice. However, in many small transactions, for 
customers to attempt to buy always at the lowest price would 
result in a waste of time and energy disproportionate to the gain. 
Hence, aside from the influence of custom and habit, there may 



536 OUTLINES OF ECONOMICS 

often be rational ground for the continued patronage of particular 
establishments and the continued purchase of particular goods 
which customers have found to be trustworthy. 

The Relation of Risks to Profits. — Profits differ from other 
forms of income in the degree to which they are contingent 
upon successful risk taking. But risk taking, in this sense, as 
we have seen, does not mean a blind dependence on chance. 
Chance is, of course, an element in profits. Capricious changes 
in fashion often bring temporarily high profits to dealers who 
happen to have the right kinds of goods in stock, or to manu- 
facturers who happen to have the equipment needed to produce 
the right kinds of goods. And other examples will suggest them- 
selves to the reader. But there are chance losses as well as 
chance gains, and there is no reason to believe that they are 
not quite as numerous and important. Chance gains, therefore, 
do not constitute any important part of the income going to 
entrepreneurs as a class, but they may often be a considerable 
element in the profits of a particular entrepreneur. 

Risk taking is nearly synonymous with business enterprise. 
It involves careful estimates of the amounts of product that can 
be got from different combinations of labor, capital, and land, 
and equally careful estimates of the salability of such products. 
It is in this latter field, which involves the diagnosis of market 
conditions with a view to ascertaining their probable trend, as 
well as the possibility of affecting them to his advantage, that 
an entrepreneur's skill finds its chief opportunity. Yet, though 
he may deal with probabilities rather than with possibilities, he 
is nevertheless a risk taker. His estimates have to do with mar- 
ket conditions that are often entirely beyond his personal 
control, and which, at best, he can influence only by efforts 
directed to that end, — by expenditures that may prove to have 
been wasted. 

To anticipate consumers' demands correctly is not in itself a 
guarantee of profits to any entrepreneur. If other entrepreneurs 
have counted on the same demand, it may easily happen that the 
total product cannot be sold at a profitable price. In fact, the 
" market conditions " which the entrepreneur has to forecast 



PROFITS 537 

include the conditions of supply as well as of demand. But even 
in case a given entrepreneur has succeeded in producing the 
precise things that consumers are demanding and other entre- 
preneurs are not producing, and has thus been able to get large 
profits, he cannot count on their permanence. Demand may 
change, but even if demand remains constant or increases, his 
large profits will be a standing invitation to other entrepreneurs 
to enter the same field, — a condition which will continue until 
competition forces the profits of this particular kind of business 
down to where they just suffice to pay the wages of management. 
If the product can be marked off, or distinguished in some way, 
good-will may be built up, as we have seen, so as to give some 
degree of permanency to profits. But even here the entre- 
preneur has to guard against the inroads of other business men, 
seeking to v/in trade for their own products. In some few cases 
profits are secured without risk ; some (not all) kinds of risks 
can be eliminated by insurance or shifted to some other risk 
taker ; but, in general, profit seeking and risk taking go hand 
in hand. 

The Entrepreneur. — We have, for convenience, spoken of 
" the entrepreneur " of an enterprise. We have also assumed 
that general managership and supervision of the undertaking 
is in the entrepreneur's hands. But the reader has been warned 
that all managerial duties may be, and often are, delegated to 
salaried employees, and that the entrepreneur may also be 
capitalist, landlord, and laborer. Most American farmers are 
all three. And most entrepreneurs in other fields supply a part 
of their own investment funds. But who, in a particular 
enterprise, is " ^Ae entrepreneur " ? 

The entrepreneur is the " business man," as distinguished 
from the capitalist, the laborer, or the landowner. He is, more 
specifically, the one who profits if a business undertaking suc- 
ceeds and who loses if it fails. Now it is clear that more than one 
person may lose if a business undertaking fails, — or others than 
the common stockholders, often regarded as " corporate entre- 
preneurs," if the business is incorporated. Bondholders, other 
creditors, laborers even, may also lose. The. fact that the bond- 



538 OUTLINES OF ECONOMICS 

holders are preferred creditors may limit their losses, but does not 
necessarily safeguard them from losing. The fact is that every 
one who has risked something on the success or failure of a par- 
ticular business undertaking is, in that degree, entrepreneur. 
The capitalist who buys 5^ per cent bonds instead of virtually 
riskless 3I- per cent bonds, or who buys 7 per cent preferred stock 
at par, the money lender who has no security other than the pro- 
spective earnings of the business, the laborer who chooses a well- 
paid but uncertain employment to a surer but lower-paid one, 
are all profit-seekers. If the business undertakings in which 
they thus cooperate succeed, they share in the profits, up to 
a stated amount; if these undertakings fail, these various co- 
operators lose, in larger or smaller amount. Their profits, if 
they get them, are surpluses over costs, the costs being meas- 
ured by the interest and wages that they could have obtained 
in virtually safe alternative employments. Wherever in. eco- 
nomic life one finds successful risk taking, there one finds profits. 
The " individual entrepreneur " and the holder of common 
stock merely assume a relatively larger burden of risk; have 
the opportunity of reaping, in case of success, correspond- 
ingly larger profits; and usually exercise a correspondingly 
larger measure of responsible direction of the policies of the 
undertaking. 

Profits and the Justification of the Competitive System. — 
It is the desire to get money profits that leads entrepreneurs to 
produce particular things and to produce them in particular 
ways. It is for this reason that old channels of productive 
effort are continually being abandoned, and that the use of 
labor, capital, and land is continually being guided into new 
channels. The shifting of productive effort which the pursuit 
of money profits involves consists, for the most part, of efforts 
on the part of entrepreneurs to meet the shifting wants of 
consumers. 

One of the strongest arguments for the superiority of the com- 
petitive system over any possible substitute for it lies in the claim 
that, under competition, the guiding of production into the 
channels indicated by the search for money profits will result in 



PROFITS ' 539 

the maximum satisfaction of human wants. This seems to 
follow from the fact that the prices people are willing to pay for 
certain commodities measure the importance which they attach 
to the possession of those commodities. The shifting of labor 
and capital from less profitable to more profitable uses means, in 
general, that more intense wants will be satisfied with the same 
expenditure of productive energy. All this is implied in the 
statement made above that the shifting of productive effort 
is mainly in response to the changing wants of consumers. This 
argument, that under free competition the pursuit of money 
profits leads to the best adaptation of productive efforts to the 
satisfaction of the wants of consumers, is one that has rarely 
been squarely met by those who attack the competitive system. 
There are, however, several important considerations that lessen 
to some extent its force. 

In the first place, the extent to which the wants of any indi- 
vidual affect the ordering of the productive process depends 
upon his purchasing power, that is, primarily, upon his income. 
It is manifestly absurd to say that the shifting of labor and capi- 
tal from the production of necessities for the poor to the produc- 
tion of luxuries for the rich, simply because it may be more 
profitable, necessarily means a better satisfaction of human 
wants. The extent to which wants are satisfied depends on the 
way wealth is distributed, as well as upon the amount and 
kinds of things produced. 

Moreover, even granting that the stimulus of money profits 
leads to the best practicable satisfaction of the wants of present 
consumers, this may sometimes be achieved by imposing added 
difficulties in want-satisfaction on future generations. The 
Unes of procedure that will bring maximum profits to entre- 
preneurs sometimes run counter to the more permanent in- 
terests of society. We all recognize, for example, that there 
may be such a thing as a too rapid exploitation of natural 
resources. The history of timber lands in America furnishes an 
instructive example. 

A still more important qualification of the statement that com- 
petitive profit seeking works for the best interests of society, 



546 ' OUTLINES OF ECONOMICS 

viewed as a body of consumers, is found in the fact that when we 
begin to speak of the interests of society, we introduce, of neces- 
sity, the ethical point of view. This means that we must con- 
sider not only the quantity but also the quality of want-satisfac- 
tions. For purposes of the economic analysis of market forces, 
we make no distinction between different kinds of wants, but 
it is impossible to discuss social well-being without taking into 
account the fact that from the point of view of the interests of 
society some kinds of want-satisfactions are good and some are 
bad, and that even the better kinds of want-satisfactions vary . 
greatly in their importance, when measured by any rational 
criterion of social welfare. The production of socially undesir- j 
able things, such as intoxicating liquors, adulterated foods, 
ill- ventilated tenem.ents, etc., is often prohibited, while, on the 
other hand, society has found that certain socially-desirable 
things, such as schools, parks, libraries, clean streets, etc.', will 
not be supplied at all, or will not be supplied in sufficient 
quantities' by private business enterprise. All indications point 
to a very considerable extension of organized social activity at 
precisely those points where the private pursuit of money profits i 
has proven itself inadequate. 

QUESTIONS 

1. Are profits as defined in accounting identical with profits as defined in 
economics.'' 

2. Is there a sense in which pure profits can be said to be a reward for 
productive services? If so, should they be counted among the expenses of 
production ? 

3. In what way are the profits of a retailer attributable to "incon- 
sistencies and maladjustments in the price situation"? 

4. Does a monopolist push his expenditures of all kinds up to the marginal 
point ? 

5. What industries, aside from agriculture, produce "standardized prod- 
ucts for a general market " ? 

6. Some economists speak of the "profits on capital." Others speak of 
profits income secured by personal exertions. Which form of statement is 
correct? Are the two necessarily inconsistent? 

7. Is good-will capital? 

8. If there were no economic risks, would profits be possible ? 



PROFITS 541 

REFERENCES 

Carver, T. N. Distribution of Wealth, Chap. vii. 

Clark, J. B. Distribution of Wealth, Chap. vi. 

Hawley, F. B. Enterprise and the Productive Process. 

Haynes, John. "Risk as an Economic Factor." Quarterly Journal of 

Economics, Vol. ix, pp. 409-449. 
Marshall, Alfred. Principles of Economics, 6th ed., Book vi. Chaps. 

vii, viii. 
Veblen, Thorstein. Theory of Business Enterprise, Chap. iii. 



CHAPTER XXVI 
THE PERSONAL DISTRIBUTION OF WEALTH 

In the present chapter we shall study the distribution of 
wealth and income among individuals simply as individuals, 
and not as agents of production or owners of productive agents. 
What is the cause of large fortunes? Is the middle class dis- 
appearing? Can we abolish poverty? To beg^n with, certain 
distinctions must be clearly drawn. 

Wealth and Income. — ■ The distribution of wealth and in- 
come should first be distinguished from the distribution of final 
consumption. We may have in mind simply the enjoyment 
of material things and services. A man of vast possessions 
•may be very frugal in his consumption, acting with respect to 
most of his property simply as a trustee for society. But when 
we are interested in social classes, industrial democracy, and 
personal power and independence, the distribution of wealth or 
income is important, no matter how frugal the owners of large 
wealth may be. 

Absolute and Relative Well-being. — Two entirely independ- 
ent inquiries are very frequently confused, (i) We may wish 
to know whether the condition of the mass of the people is get- 
ting better or worse. Do they have more or less of the good 
things of life than their ancestors had? But we may also ask, 
(2) What share of the total product of industry is received by 
each section of the community ? Which section is gaining upon 
the others? If A and B divide a catch of ten fish equally to- 
day, and if to-morrow A gets ten out of a total catch of thirty, 
then absolutely his income has increased, but relatively it has 
declined. 

Concentration of Wealth and Large-scale Production. — It is 
perhaps worth while to warn the reader against confusing the 

542 



THE PERSONAL DISTRIBUTION OF WEALTH 



543 



question of large and small fortunes with the question of large 
and small scale production. However improbable, it is at least 
conceivable that there might be an equality of property with 
production carried on largely as it is today,- for we have but to 
imagine an equal distribution of holdings of stocks and other 
equities in business enterprise. 

Methods of Measuring Concentration of Wealth and Income. 
— How shall we tell whether the middle class is tending to dis- 
appear ? A common method is to make a classification of wealth 
and income, and then to compare the number of persons in 
each class at different dates. The unreliability of the conclu- 
sions based on such a procedure is made clear by the following 
hypothetical illustration : Let $ioo be distributed among ten 
persons as follows: $i, $3, $5, $7, $9, $11, $13, $15, $17, $19. 
Then suppose each individual's holding is doubled, thus : $2, 
$6, $10, $14, $18, $22, $26, $30, $34, $38. Relatively to each 
other they are all in the same position as before, but by the 
erroneous method of comparison referred to, there appears to 
have been a concentration because the number in the highest 
class has increased most rapidly : 

TABLE I 



Class 


Number 


Dollars 


First Case 


Second Case 


and less than 5 

5 and less than 10 


3 

2 

3 


I 
I 


10 and less than 15 


2 


15 and over 


6 



A satisfactory method of comparing the distribution of wealth 
at different epochs must take account of the changing significance 
of fixed classifications when there has been a change in the per 
capita wealth. This can be done by observing what proportion 
of the wealth is owned by certain sections of the population, 
such as the poorest third, the middle third, or the upper third. 



544 OUTLINES OF ECONOMICS 

If a larger proportion of the total wealth falls into the hands of 
the upper third, we may say there is evidence of a growing con- 
centration of wealth. It is clear that no definite movement is 
necessarily discernible even when changes are taking place, for 
these changes may tend toward concentration in one part of 
society and toward diffusion in another. 

Statistics of Distribution. — There are many investigations 
showing the earnings of particular classes of workers, but in the 
United States there is no reliable statement of the division of the 
national wealth or income among all classes of society. We can- 
not use the property tax assessments for this purpose because of 
their inaccuracy, and because of the fact that one individual 
may be taxed in various jurisdictions. The returns of the pro- 
bate courts have been used as a basis for a statement of wealth 
distribution in the United States on the assumption that the dis- 
tribution of wealth among persons who die in any year is an 
index of the distribution of wealth among those who are living. 
But the incompleteness of our probate returns makes this method 
also a hazardous one. The federal income tax returns will 
yield some valuable data regarding the number of higher in- 
comes when the material is properly tabulated for that purpose. 

Out of very inadequate material, however, Professor W. I. 
King has constructed the estimates shown in Table II. His 
figures indicate, further, that the richest 2 per cent of the 
families in the United States get about one fifth of the aggre- 
gate income, while the poorest two thirds of the families get 
about 39 per cent of the aggregate income. These estimates 
cannot be supposed to be entirely accurate, but the impression 
they give is undoubtedly correct in its general outlines. 

The growth of the number of millionaires has been used as an 
evidence of growing wealth concentration, but it should be 
noted that a growth of population and wealth in a community 
would cause an increase in the number of millionaires, even if 
the relation between the various classes remained the same. 
Suppose that in 1850 there had been in the United States but 
fifty millionaires, that three hundred and fifty persons had from 
$750,000 to $1,000,000, and that six hundred persons had from 



THE per:sonal distribution of wealth 



545 



$500,000 jto $750,000. If the population had remained the 
same and every one's wealth had been doubled, in 1900 there 
would have been one thousand millionaires, and if the popula- 
tion -at the same time increased fourfold, with the relations 
among the new population the same as in the old, we should 
then have four thousand millionaires without any tendency 
toward concentration. Nevertheless, the increase of large for- 
tunes has been so startling that in spite of these considerations 
one may perhaps regard them as an indication of a growing con- 
centration of wealth. The lists of very rich men published in 
the United States from time to time are instructive on this point. 
In 1820 men with a personal property of $20,000 were included ; 
in 1846 a total property of $50,000 was considered very large ; 
in 1855 this was doubled ; in 1892 a man had to be a million- 
aire to be considered very rich, and at present one may speak 
of even a billionaire. 

TABLE II 

Distribution of Incomes in the United States: 1910I 



Incomes 
IN Dollars 


Per Cent of Families 

RECEIVING Less than 

Stated Incomes 


Incomes 
IN Dollars 


Per Cent of Families 

RECEIVING Less than 

Stated Incomes 


200 


.07 


1500 


90.31 


300 


1.04 


1800 


93-67 


400 


7.17 


2000 


94.86 


500 


16.70 


2400 


96.18 


700 


38.92 


3000 


97.42 


1000 


6943 


3600 


98. 10 


1200 


81.69 


4000 


98.39 



More satisfactory statements can be made for those countries 
which collect an income tax. The following figures for 1892 
and 1902 are from a table prepared by Professor Wagner, in a. 
study of the income-tax returns of Prussia, and the correspond- 
ing figures for 191 3 have been added : 

1 From W. I. King, Wealth and Income of the People of the United States, p. 228. 
2N 



546 



OUTLINES OF ECONOMICS 



TABLE III 

Incomes in Prussia: 1892, 1902, and 1913I 



Incomes in 
Dollars 


Per Cent of Persons 

(Heads of Families or Self- 

Supporting Individuals) 


Per Cent of Income 
(That below S214 is estimated) 




1892 


1902 


1913 


1892 


1902 


1913 


Below 214 . . . 

214-714 . . . 
714-2261 . . 
2261-7259 . 
7259-23800. 
Over 23800, 


78.18 
18.98 
2.33 
0.41 
0.08 
o.oi 


70.66 
25-83 
2.88 
0.51 
o.io 
0.02 


52.49 

42.12 

4-53 

.68 

.14 

.04 


41.21 

30.01 

12.83 

7-37 

4.65 

3.93 


32.97 

34-92 

13-73 

7.84 

5. 13 

5.40 


18.28 

46.25 

15.84 

8.12 

S.62 

5-89 


Absolute 
amounts 
(Total) .... 


Number 
11,162,000 


Number 
12,813,000 


Number 
15,404,855 


Dollars 
2,309,076,000 


Dollars 
3,039,498,000 


Dollars 

4,736,000,000 



The great mass of the people even in 19 13 were too poor to pay 
any income tax at all, the minimum income taxed being $214. 
About 5 per cent of the population at the top received about one 
third the total income in 19 13, but in connection with such a 
statement it should be said that even if incomes should be 
equally distributed, the average income per family, or single 
adults, would be very small. In 1902 the average money 
income was $237 and in 1913 it had risen to $307. This 
absolute increase in money incomes among the poorest class 
of the people is shown in the table in the much smaller propor- 
tion of the population found in the class with incomes below 
$214 in 1913 than in 1902. This increase in money income 
does not necessarily mean greater well-being or greater equal- 
ity, but the table as a whole shows no marked tendency 
toward a concentration of incomes in the hands of the upper 
classes. 

When we turn from the question of relative well-being to that 
of the actual condition of each class taken by itself, we find two 
facts standing out prominently: (i) the fruits of economic 



1 From Zeilsckrifl des Preussichen Statistischen Bureaus, 1904, p. 231, and Statis- 
tisches Jahrbuchfiir den Preussischen Staat, 1913. 



THE PERSONAL DISTRIBUTION OF WEALTH 547 

progress have not been confined to a small class, but have been 
shared by the masses, and (2) a surprisingly large section of the 
population is still in poverty. 

With respect to the first fact, we may say that in material 
comforts the people of this generation are better off than they 
have ever been before. The work of settlement in which so 
many of our forefathers engaged was laborious and exhausting. 
Food was often scarce, disease was rife in many settlements, 
and the women and children in particular suffered greatly. 
After the wilderness was cleared, there ensued a period of 
" rude plenty." Food was abundant, but it was coarse in 
quality and restricted in variety, whilst everything that' 
had to be brought from a distance was very expensive. 
Education was difficult to secure, books scarce, and the 
lives of most people were, in the main, monotonous and 
uneventful. 

The course of wages from the middle of the eighteenth cen- 
tury to the year 1905, and the movement of prices from i860 
to the latter date, are given in Table IV following. The figures 
are not altogether comparable, nor so trustworthy as could be 
wished, but the general impression which they give is correct 
for the period covered. Speaking generally, money wages 
have steadily risen, and the hours of labor have declined, with 
minor interruptions, since the colonial period, while prices have 
fluctuated irregularly. This table cannot be given in the same 
form for later years, but a recent study covering the period 
from 1890 to 191 2 shows that the purchasing power of hourly 
wages, although increasing from 1890 to 1905, fell rapidly 
after that date owing to the rapid increase in prices, so that 
an hour's wages purchased less in 191 2 than in any previous 
year of the period. As the number of hours per week de- 
creased steadily from 1890 to 191 2, the purchasing power of 
a week's wages was only about 85 per cent of what it had 
been in 1890. Purchasing power here is measured by retail 
prices of food. ^ 

1 1. M. Rubinow, "The Recent Trend of Real Wages," American Economic 
Review, Vol. iv, p. 811. Cf. the table on p. 341, above. 



548 



OUTLINES OF ECONOMICS 
TABLE IV 



Wages, 


Prices', and Hours of Labor 
□ST i860 taken as 100 


Wages, Prices, and 
OE Labor in 1890 
AS 100 


Hours 

TAKEN 






Day Laborers in 
Massachusetts ' 


Employees in Manufacturing 
Industries — Eastern States 


General Industry, excluding 

Agriculture, Mining, and 

Transportation 




Rela- 
tive 
Wages 


Year 


Relative 


Year 


Relative 


Period 


Wages= 


Cost 
of 

Living^ 


Hours 

of 
Labor ^ 


Wages ^ 


Prices 5 


Hours 

of 
Labor ^ 


1752-60 


.29 


i860 


100 


100 


100 


1881 


95-3 


II4-5 


103 


1761-70 


•325 


1861 


100 


III 


99.1 


1882 


96.9 


II7-5 


103 


1771-80 


•376 


1862 


100 


123 


98.2 


1883 


97-7 


II4-8 


103 


1781-90 


.428 


1863 


109 


137 


98.2 


1884 


98.5 


107.7 


103 


1791-00 


.623 


1864 


120 


163 


98.2 


1885 


97.8 


100.8 


103 


1801-10 


.817 


1865 


141 


175 


97-3 


1886 


97.8 


99.6 


102 


1811-20 


.910 


1866 


^53 


172 


98.2 


1887 


98.6 


100.3 


100 


1821-30 


.796 


1867 


172 


164 


98.2 


1888 


99.2 


102. 1 


100 


1831-40 


.872 


1868 


167 


165 


96.4 


1889 


99.6 


102. 1 


100 


1841-50 


.852 


1869 


174 


163 


96.4 


1890 


100. 


lOO.O 


100 


1851-60 


•975 


1870 


17s 


157 


95-5 


1891 


99-7 


IOI.4 


99.8 






1871 


178 


148 


95-5 


1892 


100.3 


99-5 


99.8 






1872 


174 


147 


95-5 


1893 


100.2 


102.0 


99.6 






1873 


175 


149 


95-5 


1894 


96.7 


97-4 


99.1 






1874 


170 


145 


95-5 


1895 


97-4 


95-5 


99.4 






1875 


161 


141 


93-6 


1896 


98.5 


93-3 


99.1 






1876 


156 


134 


93-6 


1897 


98.2 


94.0 


98.9 






1877 


146 


131 


93-6 


1898 


99.0 


96.4 


99.0 






1878 


142 


. 126 


93-6 


1899 


100.2 


97.2 


98.5 






1879 


140 


123 


93-6 


1900 


103. 1 


98.7 


98.0 






1880 


137 


125 


93-6 


1901 
1902 
1903 
1904 
1905 


104.8 
108.2 
III. 2 
III. I 
112.8 


102.7 
108.3 
107.7 
109. 1 
109.8 


97-4 
96.6 

95-9 
95-2 
95-2 



1 Data from Report of Massachusetts Bureau of Statistics of Labor for 1885, 
P- 455- 

^ Data from Mitchell, Gold, Prices, and Wages under the Greenback Standard, 
pp. 242-244. The cost of living here is based upon retail prices and covers rent as 
well as food, etc. 



THE PERSONAL DISTRIBUTION OF WEALTH 549 

Regarding the second fact, we may say that certain English 
investigations show that more than one fourth of the population 
of the cities of London and York are below the poverty line. 
To be sure, it is not easy to determine definitely how poor a 
person must be in order to be " in poverty," but the statement 
just made is based upon standards that are undeniably con- 
servative. But a number of those actually in poverty have 
enough income to purchase the minimum physical requirements 
if they knew how to spend their money wisely. In the city of 
York 9.91 per cent of the population had insufificient earnings 
for minimum requirements estimated at $5.25 per week for a 
family of five. This minimum is very low, and it is easily 
within the mark to say that at least a fifth of the population of 
York did not have in 1899 a sufficient income for a decent 
existence. In the United States the proportion of the urban 
population below the poverty line is probably somewhat less, 
but reliable statistics cannot be quoted. 

An American writer has estimated that ten million persons in 
the United States are in poverty, not all in distress, but " much 
of the time underfed, poorly clothed, and improperly housed." 
The estimate is based on statistics of unemployment, returns of 
boards of charity, court records of evictions, and pauper burials. 
Whatever the actual figures may be, they would doubtless be 
startling in comparison with statistics of our industrial progress. 

Causes of Poverty and Riches. — - The explanations of poverty 
and riches may be divided into two classes : (i) those that em- 
phasize individual responsibility, and (2) those that emphasize 



5 Based upon statistics covering 21 industries given in the Aldrich Report oij 
Wholesale Prices, Wages, and Transportation. 

^Statistics for i88i-i88g cover 25 city occupations, and are based upon data 
given in Bulletin of the Bureau of Labor, No. 18, p. 66g. Statistics for iSgo-igos 
cover 34g occupations, and are based upon data given in Bulletin of the Bureau of 
Labor, No. 65, p. 20. 

^ Wholesale prices from 1881 to i88g, based upon data given in the Aldrich Report 
on Wholesale Wages, Prices, and Transportation, Part i, p. gg. Retail prices of food 
from i8go to igos, from the Bulletin last cited. 

* From the Aldrich Report and Bulletin cited above. After i8go, statistics are 
based on hours of labor per week. 



550 OUTLINES OF ECONOMICS 

social responsibility. According to the first, a comfortable for- 
tune is the reward of efficiency, and poverty the penalty of in- 
efficiency. To find fault with existing wealth distribution, it 
is alleged, is to find fault with nature for making individual 
differences in ability so enormous. That there are idle and 
worthless persons among the rich is not to be denied, but they, 
it is said, are to be regarded as the exceptions. As a class, 
according to this view, the rich add more to the wealth of society 
than they consume, and they do not in reality deduct any- 
thing from the income of the lower classes. 

Those who emphasize the second explanation, on the other 
hand, point to the existence of all sorts of special privileges 
which enable the few to levy toll on the production of the nation. 
They assert that the fortunes of most millionaires originated 
under the shelter of some monopolistic enterprise. As to the 
poor, they call attention to the fact that inefficiency may be 
the result of poverty as well as the cause of it. Society must, 
therefore, take active measures to better the environment of 
the poor. They must be taught to live wisely, and their chil- 
dren must be given a fair chance in life. Children who do not 
get enough to eat when young cannot be expected to take care 
of themselves when they are men and women. 

"The prime importance of monopoly privileges in the distribution of 
wealth is shown by the results of the investigation of the New York Tribune 
(1892) in its efforts to ascertain the sources of the fortunes of the millionaires 
of the United States. That investigation was undertaken to show that the 
system of protection has not been the main cause for monopolies and great 
fortunes. The investigation amply .demonstrated this proposition. Of 
the 4047 millionaires reported, only 1125, or 28 per cent, obtained their 
fortunes in protected industries. The following partly estimated summaries 
are based on the Tribune report. They show that about 78 per cent of the 
fortunes were derived from permanent monopoly privileges and only 21.4 
per cent from competitive industries unaided by natural and artificial mo- 
nopolies. Yet there can be no question that if these 21.4 per cent were fully 
analyzed, it would appear that they were not due solely to personal abilities 
unaided by these permanent monopoly privileges. They were mostly 
obtained from manufactures, and five sixths of the manufactures of the 
country are based on patents. Besides, fortunate investments in real estate, 
stocks, etc., have often contributed to fortunes where they do not appear 



THE PERSONAL DISTRIBUTION OF WEALTH 551 

prominently. Furthermore, if the size of the fortunes is taken into account, 
it will be found that perhaps 95 per cent of the total values represented 
by these millionaire fortunes is due to those investments classed as land 
values and natural monopolies and to competitive industries aided by such 
monopolies." ^ 

Those who take this second view do not deny that individual 
differences in ability exist and are a cause for a difference in for- 
tune. But they think that conditions are such that differences 
in reward are quite out of proportion to the difference in ability. 
A little shrewdness may accumulate a fortune just as the touch 
of a child's hand may start a bowlder down the mountain side. 

The controversy as to the ultimate responsibihty for poverty 
cannot be settled by an appeal to the results of the investigations 
that have been made as to the immediate causes of poverty. 
The investigation in the city of York, before referred to, gives 
the following as the immediate causes of primary poverty, that 
is, of incomes insuflScient to provide the minimum requirements 
for physical efficiency even if wisely spent : 

TABLE V 

Immediate Causes of "Primary" Poverty ^ 



Per Cent of Population 
IN Poverty 



Death of chief wage earner 

lUness or old age of chief wage earner 
Chief wage earner out of work .... 

Irregularity of work 

Size of family, i.e. more than four children 
In regular work but at low wages . . . 



15-63 

2.31 

2.83 

22.16 

51.96 



Is Greater Diffusion Possible ? — Most people agree that a 
greater equality of possessions would be desirable if it could be 
brought about without any confiscation of the real earnings of 
the more efficient members of society. The idea of a leisure 

> J. R. Commons, The Distribution of Wealth, p. 252. 
2 B. S. Rowntree, Poverty, p. 120. 



552 OUTLINES OF ECONOMICS 

class whose mission it is to further culture without substantial 
contributions to the production of what it consumes, does not 
find much favor in this democratic age. The disadvantages of 
wide extremes in wealth have been so often pointed out by 
social philosophers that they need not be emphasized here. 
But those who believe that the competitive system roughly 
apportions rewards according to individual production will say 
that nothing can be done directly to diffuse wealth. That 
each individual should bear the consequences of his own con- 
duct, they think, is necessary as a discipline for the race. " Give 
the children of the shiftless, by thoughtless charity or various 
systems of poor relief, the right to eat the substance of the effi- 
cient and the prudent, and you will soon lose both the capital 
and the morality under which that capital has been created," ^ 
says one able writer. 

Those, on the other hand, who think that something can and 
should be done, question the possibility of discovering the real 
contributions of individual workers under modern complex in- 
dustrial conditions with any degree of exactness, and think there 
is little danger of discouraging industry and thrift. If the 
highest incomes were $100,000 per year, men would struggle just 
as hard as they do now to get into the highest class. 

If we take the view that something can be done to lessen the 
extreme inequality in wealth distribution that exists at the 
present time, it is necessary to formulate some program of 
social reform. In framing such a program it must be re- 
membered, on the one hand, that the right of private property 
is not an absolute right. No one has a vested interest in that 
institution, and we are at liberty to make such modification in 
the institution as will contribute to the social welfare. For the 
present the measures here advocated are not in the slightest 
danger of being carried so far as to discourage that wealth- 
getting ambition which is considered by many to be essential 
to progress. On the other hand, there is danger of injuring by 
wrong methods the very persons whom it is desirable to elevate. 
Indiscriminate charity may convert poverty to pauperism. 

^ A. T. Hadley, Economics, p. 49. 



THE PERSONAL DISTRIBUTION OF WEALTH 553 

"This distinction between the poor and the paupers may be seen every- 
where. There are, in all large cities in America and abroad, streets and 
courts and alleys where a class of people live who have lost all self-respect and 
ambition, and who rarely if ever work, who are aimless and drifting, who hke 
drink and who have no thought for their children, and who live aimless and 
contentedly on rubbish and alms. ... In our American cities,Negroes, 
Whites, Chinese, Mexicans, Half-breeds, Americans, Irish, and others are 
indiscriminately housed together in the same tenements and often in the 
same rooms. The blind, the crippled, the consumptive, the aged, — the 
ragged ends of life; the babies, the children, the half-starved, underclad 
beginnings in life, all huddled together, waiting, drifting. This is pauper- 
ism. There is no mental agony here; they do not work sore; there is no 
dread; they hve miserably, but they do not care. 

"In these same cities, and indeed everywhere, there are great districts of 
people who are up at dawn, who wash and dress, and eat breakfast, kiss 
wives and children, and hurry away to work or to seek work. The world 
rests upon their shoulders ; it moves by their muscle ; everything would stop 
if for any reason they should decide not to go into the fields and factories and 
mines. But the world is so organized that they gain enough to live upon 
only when they work ; should they cease, they are in destitution and hunger. 
The more fortunate of the laborers are but a few weeks from actual distress 
when the machines are stopped. Upon the unskilled masses want is con- 
stantly pressing. As soon as employment ceases, suffering stares them in 
the face. They are the actual producers of wealth, but they have no home 
nor any bit of soil which they can call their own. They are the millions who 
possess no tools and can work only by permission of another. In the main 
they live miserably, they know not why. They work sore, and yet gain noth- 
ing. They know the meaning of hunger and the fear of want. They love 
their wives and children. They try to retain their self-respect. They have 
some ambition. They give to neighbors in need, yet they are themselves the 
actual children of poverty." ^ 

We shall not discuss here the methods of alleviating the suf- 
fering that comes from poverty. The best methods of charit- 
able relief are necessary as palliatives, but th'ey cannot cure the 
evils of poverty. Two classes of reform measures should be 
distinguished : (i) those that aim to alter the methods of wealth 
acquisition in the future, and (2) those that aim to diffuse the 
excessive accumulations of the past. 

Modifying the Methods of Wealth Acquisition. — These 
measures again fall into two classes : (a) prevention of improper 

1 R. Hunter, Poverty, pp. 3-5. 



554 OUTLINES OF ECONOMICS 

methods of wealth accumulation ; (b) eliminating or strengthen- 
ing the inefificient members of society. Under the first of these 
falls the problem of reducing to lower terms such incomes as 
are individually unearned. There must be such control of 
monopolistic privileges as to keep them from being the means 
of exploiting the public. Fraud and favoritism must be elim- 
inated so that income shall not be wholly out of proportion 
to service or needs. 

The second class includes a large variety of methods, (i) It 
is possible to do something to prevent defective human beings 
from being born. There is a growing sentiment in favor of 
preventing the marriage of persons who are not fit for marriage. 
No individual would be deprived of any important right if a 
medical certificate of good health were made a condition pre- 
cedent to the granting of a marriage license, although here 
education may prove the more effective remedy. (2) Education 
should be made compulsory, with the endeavor of making the 
rising generation not only efficient producers, but also wise 
spenders of what they receive. (3) It is possible to provide 
against the misfortunes of fife by Insurance of various kinds. 
If men will not voluntarily make provision for themselves and 
for those dependent upon them in cases of sickness, accident, 
old age, and premature death, they should be helped to do so 
indirectly by some comprehensive system of workingmen's 
insurance and old age pensions. (4) The solution of the prob- 
lem of unemployment depends in part upon indirect measures, 
such as monetary and banking reform, which steady the prog- 
ress of industry, although more efficient labor exchanges and 
unemployment insurance are direct measures which are of some 
help. If business men and political leaders ever become as 
much interested in the problems of unemployment as in tariff 
reform, we may expect that productive use will be found for 
the unemployed so far as they are employable, and if this proves 
impracticable, we shall recognize that if society cannot offer 
a wilHng and able man an opportunity to work, it must give 
him a vacation with pay. (5) Opportunities for saving should 
be multiplied. The establishment of our postal-savings system 



THE PERSONAL DISTRIBUTION OF WEALTH 555 

is a small step in this direction. (6) The health and vigor of 
the people should be improved by more efficient use of " pre- 
ventive medicine " and public hygiene in all its various phases, 
and by improvement in the conditions of work. 

The Diffusion of Wealth. — To some extent large fortunes dis- 
appear without governmental interference, but it takes com- 
paratively slight ability to maintain an inherited estate. It 
does not seem practicable or desirable to limit directly the total 
amount of wealth which a man may own, but there is no reason 
why the government should refrain from consciously encourag- 
ing the diffusion of wealth. The regulation and taxation of 
inheritances seems to be the proper remedy in this connection, 
even if its action is somewhat slow. 

QUESTIONS AND EXERCISES, 

1. Can anything be said in favor of a leisure class? 

2. Would Mr. Carnegie's plan of levying an inheritance tax of 50 per cent 
destroy the incentive to work ? 

3. Explain the various systems of poor relief. 

4. Describe the work of some public employment office. 
5: Describe the growth of postal savings. 

6. What were the causes of the development of the fortune of John Jacob 
Astor? 

7. Discuss the following statement: "We have, then, little reason for 
expecting that the prevailing insecurity in the lot of the modern workman 
will ever be removed by the development of individual thrift." — A. S. John- 
son, Political Science Quarterly, Vol. xxii, p. 244. 

REFERENCES 

Adams, T. S., and Sumner, H. L. Labor Problems, Chap. v. 

Brooks, J. G. The Social Unrest, Chap. vii. 

Booth. Life and Labour of the People in London, final volume. 

Commons, J. R. Distribution of Wealth, pp. 252 seq. 

Devine, E. T. Principles of Relief. 

Ely, R. T. Property and Contract, Vol. i, Chap. xiii. 

Falkner, R. p., "Income Tax Statistics," Quarterly Publications of the 

American Statistical Association, Vol. xiv, p. 521. 
Hadley, a. T. Economics, pp. 39-63, 330-335. 
Hollander, J. H. The Abolition of Poverty, Chaps, ii, viii. 
Hunter, Robert. Poverty. 



556 OUTLINES OF ECONOMICS 

HoBSON, J. A. The Social Problem, Chap, iv; Problems of Poverty, Chap. ix. 

Henderson, C. R. Modern Methods of Charity. 

Johnson, A. S. "Influences affecting the Development of Thrift," Political 

Science Quarterly, Vol. xxii. 
King, W. I. The Wealth and Income of the People of the United States. 
RowNTREE. Poverty: A Study in Town Life. 
Streighthoff, F. H. "The Distribution of Incomes," Columbia University 

Studies in History, Economics, and Public Law, Vol. iii, No. 2. 
Taussig, F. W. Principles of Economics, Vol. ii. Chap. liv. 
Warner, A. G. American Charities. 
Watkins, G. p. "The Growth of Large Fortunes," Publications of the 

American Economic Association, Third Series, Vol. vii, No. 2. 
Youngman, Anna. Economic Causes of Great Fortunes. 



PART IV 

SELECTED ECONOMIC PROBLEMS 

CHAPTER XXVII 
TRANSPORTATION ECONOMICS 

Transportation Economics Defined. — Transportation may 
be studied from various points of view. It presents its peculiar 
problems to the engineer, to the lawyer, to the financier, to the 
accountant, to the operating official, and finally to the economist. 
The economist studies the relations of transportation to other 
industries and to the public welfare. Leaving to the engineer 
the building of bridges, to the accountant the recording of the 
condition of the business, and to the general manager the 
securing of efficient operation, we turn our attention primarily 
to the principles that govern the determination of rates and 
fares, although there are many other problems to be considered 
in transportation economics, some of them peculiar to this 
field and some but special illustrations of principles underlying 
all industry. We make use of the technical knowledge of the 
engineer and of the other specialists that have been mentioned, 
and yet our point of view is distinct. 

Scope of the Term Transportation. — A complete treatment 
of the subject of this chapter would involve a consideration of 
steam railways, interurban and city railways, the common 
roads, water transportation, as well as the post office, the tele- 
graph and the telephone. Aerial transportation may bring new 
economic problems in the future. But it will be necessary in 
this chapter to confine the discussion to some of the leading 
principles in the economics of railroad transportation. As 

557 



558 OUTLINES OF ECONOMICS 

explained in Chapter VI, the early turnpike era was followed by 
one of canal building, and this in turn by the railroad era. We 
are now realizing that we must enter upon a new era of road 
building and of the improvement of waterways. Canal and 
river improvement, however, should be urged, not on the general 
ground that water transportation is cheap, but only in specific 
instances where it can be shown to be as advantageous as rail 
transportation when all of the elements of expense are taken into 
consideration. It is a matter of debate, for example, whether 
the recent construction of the New York barge canal was 
economically justified. The improvement of our common 
roads is now being vigorously forwarded by state and local 
activity. In 1916 the federal government made an appropria- 
tion to aid the states in carrying on this work. 

Nature of the Railway Industry. — Hardly anything can be 
produced without the participation of some transport agency. 
Modern industrial civilization would be impossible without an 
efficient system of commercial intercourse. The dependence is 
mutual, for present methods of transportation clearly would be 
vmeconomical without a large traffic. The influence of cheap 
transportation is especially important in the fact that it promotes 
an extensive division of labor by widening the market. It per- 
mits each region to devote itself to that line of production for 
which it is best adapted. 

The number of persons employed by railways in the United 
States in 1910 was about 1.7 millions, which was 4.45 per cent 
of the number of gainful workers reported by the census of that 
year. This percentage probably understates the relative impor- 
tance of transportation as compared with other economic ac- 
tivities, because the capital per employee is larger in the railway 
industry than in other lines of work. An attempt has sometimes 
been made to minimize the importance of the question of rail- 
road rates by comparing the transportation charge on such an 
article as a pair of shoes with the cost of the shoes and showing 
that it is too small appreciably to affect the retail price. This 
overlooks the fact that freight charges enter into the cost of the 
materials and of the machinery required to produce the shoes. 



TRANSPORTATION ECONOMICS 559 

The freight charge constitutes a large percentage of the cost of 
such an article as coal. But, on the other hand, the importance 
of changes in freight rates is sometimes overemphasized by com- 
paring the total annual freight revenue per family with the 
estimated income of the average family. Thus in the year 
ending June 30, 1910, the freight revenue of railways in the 
United States was $1,925,553,036, and the number of families 
as reported by the census of 1910 was 20,255,555, making 
an average of ninety-five dollars per family. It should be 
obvious that this figure cannot be compared with the amount 
which the average family spends for food, clothing, and- other 
items of final consumption. If the comparison is made at 
all, it must be with the total annual production of the nation 
per family, for freight charges enter into the cost of such 
items as the factories, war-ships, and railway bridges con- 
structed each year as well as of the articles produced for final 
consumption. 

Railways differ from manufacturing industries in that they 
produce place utility and not form utility, and in the further 
fact that it is customary for manufacturers to own the materials 
which they change in form while railways as a rule do not own 
the materials which they transport. In other words, railways 
sell services simply, while manufacturers sell articles in which 
they have embodied certain services. The freight charges paid 
by the shipper may be compared with the toll which the farmer 
used to pay for having his corn ground at the mill. The fact 
that railways do not buy and sell the commodities to which they 
add utility as manufacturers do, makes the amount of their 
yearly income and outgo much smaller in comparison with the 
amount of capital employed than is the case with manufacturers. 
Roughly speaking, it takes railways five years to " turn over " 
their capital, the total operating revenues of the railways in the 
United States being about three billions of dollars a year, while 
their capitalization is about fifteen billions (excluding intercor- 
porate duplications). For the year 1909, the Bureau of the 
Census reports manufacturing establishments as having a capital 
of 18.4 billions of dollars and an annual value of products of 



560 OUTLINES OF ECONOMICS 

20.7 billions. The value of products less cost of materials pur- 
chased, that is, the value added by the manufacturing process, 
was 8.5 billions. While no accurate comparisons are possible 
from these data, they warrant the conclusion that capital is 
relatively much more important as a factor of production in the 
railway industry than in manufacturing enterprises taken as a 
whole. The fact that railway services are rendered in con- 
nection with a large fixed capital explains much in our railway 
history, especially with respect to matters relating to competi- 
tion, monopoly, and rate making. 

Railway Competition. — The early roads were short, independ- 
ent lines, largely for local trafi&c or to serve as feeders to canals. 
The first movement toward the efficiency of the present system 
was the welding together of separate links into through lines. 
The New York Central, for example, was formed in 1853 out of 
ten or eleven previously independent lines between Albany and 
Buffalo. The development of parallel through lines introduced 
an era of sharp competition. In the seventies the lines connect- 
ing Chicago and the Atlantic seaboard engaged in a series of rate 
wars. The experience of this decade showed clearly the tempo- 
rary and unstable character of competition among parallel lines. 
The rule seemed to be that a railway war must be followed by a 
rate agreement of some sort, so that instead of the maintenance 
of a supposedly fair level of rates by the steady pressure of com- 
petition, we find there was an alternation of high and low rates. 
The inevitable annihilation of direct competition in rates be- 
tween railways is clearly portrayed in a congressional report in 
1874, where the following prediction was made : "But when the 
natural tendencies of corporate power have wrought out their in- 
evitable conclusions, the magnitude of our combinations will 
probably be in proportion to the extent of the field in which they 
operate." But so strongly was it felt at that time that competi- 
tion is the life of trade, that the committee which made this 
report recommended that the government build a line of its 
own, merely to maintain competition with the private roads, for 
it was thought that the government could resist the temptation 
to enter into a combination. 



TRANSPORTATION ECONOMICS 56 1 

The history of Belgium affords an instructive illustration of the effect of 
a mixed system of public and private ownership. Belgium began in 1837 
with a carefully planned system of public railways. Ten years later it 
was decided to grant charters to private companies. A large number of 
private roads was organized, some with the purpose of competing with the 
state system. It was thought that competition between the state and private 
roads would be beneficial. The Massachusetts Railroad Commission, in its 
report of 1871, recommended a trial of this plan in Massachusetts. But in 
Belgium the private lines were soon merged into four systems, which com- 
peted so vigorously with the state roads that the government adopted the 
policy of purchasing them. 

Pooling and Consolidation. — As a result of the intense struggle 
for business among the roads, there was a widespread resort to 
the practice of pooling, that is, a division of the earnings or ton- 
nage of the aggregate business. This form of combination, 
however, was at least nominally abandoned after it was declared 
illegal by the Interstate Commerce Act of 1887, but organiza- 
tions for the purpose of making rates continued to exist. In 
1897 these were also declared illegal by the Supreme Court of the 
United States on the ground that they were in violation of the 
Anti-trust Act of 1890.^ The decision, however, did not clearly 
prohibit the enlargement of the various systems by the purchase 
and lease of other lines, or by securing indirect control by the 
purchase of the majority of their stock. But in 1904 the Su- 
preme Court again applied the Anti-trust Act of 1890 in a case 
against the Northern Securities Company, a corporation formed, 
not for the purpose of directly engaging in the railway business, 
but for the purpose of holding the capital stock of the Great 
Northern, Northern Pacific, and Burlington systems, two of 
which were competing systems. In 191 2 it was decided that for 
the Union Pacific Railroad Company to hold indirectly 46 per 
cent of the stock of the Southern Pacific Company was illegal, 
although only a small percentage of the total traffic of these 
roads could be regarded as competitive. The Northern Securi- 
ties decision did not prevent the systems involved from con- 
tinuing to be controlled by the same financial interests, but the 
Union Pacific case has apparently resulted in severing the finan- 

1 See p. 237, above. 
•20 



562 OUTLINES OF ECONOMICS 

cial control of the Union Pacific from that of the Southern 
Pacific. 

The present organization of any one of our large systems, like 
a geological record, reveals the nature of the changes that have 
been going on. The consolidated company controls a number of 
large lines, perhaps by stock ownership, and each one of these is 
made up of a number of subsidiary roads united as a result of 
purchase, partial stock ownership, or lease. 

Thus the Baltimore and Ohio in 191 2 operated 4455 miles of 
line, of which it owned 545 miles, while 3897 miles were con- 
trolled through partial or complete stock ownership, the re- 
mainder being operated under lease or trackage rights. It also 
controlled the Cincinnati, Hamilton, and Dayton, an independent 
operating company. There are numerous illustrations of the 
control of one large operating company by one or more other 
operating companies. Thus the Northern Pacific and Great 
Northern Companies jointly control the Burlington. Again, 
several operating companies may be controlled by a holding com- 
pany which does not itself operate any mileage. This is the case 
with the Louisville and Nashville and the Atlantic Coast Line 
Railroads, both of which are subsidiary to the Atlantic Coast 
Line Company. Again, two or more railroads, apparently quite 
independent of each other in the matter of stock ownership, may 
nevertheless be dominated by the same financial interests. Thus 
the Morgan interests control the Erie and the Southern as well 
as other railroads. It is safe to say that ten groups of capital- 
ists control over three fourths of the railway mileage of the 
United States. 

In spite of the progress of consolidation, competition has not 
entirely disappeared. Even where there is no active cutting 
of rates by parallel lines, there may be rivalry in service ; but 
this form of competition has also proven to be unstable and- 
unsatisfactory, as is seen in problems arising in connection with 
terminal freight services. Again, alternative routes may lead 
to competition among railways that are not parallel. Thus 
the roads serving the north Atlantic ports compete in the 
carriage of grain with those extending to Galveston and New 



TRANSPORTATION ECONOMICS 563 

Orleans. The influence of water competition on railway rates 
has been recognized by the Interstate Commerce Commission in 
the adjustment of transcontinental rates and in the numerous 
exceptions it permits in the southern states to the rule that the 
charge for the shorter haul shall not exceed that for the longer. 
The activities of the traffic departments of railways indicates 
the existence of competition for business at many points. 
The Panama Canal will be a factor in railway competition. 

Much has recently been said about the influence of market 
competition as a force affecting rates, even when the roads have 
been consolidated. To illustrate, the farmers and railways of 
North Dakota are joint producers of wheat, and they are both 
desirous that it shall be sold in competition with other wheat in 
the London market. It would be ruinous to the roads to make 
such high rates that the farmers could not afford to sell their 
grain. The railways cannot be prosperous if the farmers, mer- 
chants, and manufacturers along their lines are not prosperous. 
This partnership, however, has its limits, for a rate which would 
enable the producer to continue in business might still be un- 
reasonably high. 

The Movement of Rates. — The average revenue per ton mile 
of traffic in the United States fell from i.ooi cents in 1888 to 
.729 cents in 1900, rising to .780 in 1904, and falling again to 
.729 in 1913. Average ton-mile receipts, however, are not an 
accurate index of changes in rates, for this average is affected 
by the changes in the nature of the traffic as well as by changes 
in rates charged. The average ton-mile revenue is really a 
weighted index number with changing weights at different peri- 
ods. If the proportion of low-grade freight increases, or if the 
length of haul increases, there will be a fall in ton-mile receipts 
without any change in rates. But if we also take into consider- 
ation rates on specific commodities, such as wheat, or stoves, 
between specific points, no doubt remains but that a large de- 
crease in freight rates took place up to the year 1900. Since 
that time there have been many increases in published rates, 
but also many decreases have been made by order of various 
regulating bodies. It may be that the net effect of these changes 



564 OUTLINES OF ECONOMICS 

is fairly well represented by the ton-mile revenue, which has 
shown little change since 1900, although there has been some 
increase in the proportion of low-grade tonnage and in the aver- 
age length of haul between 1900 and 1913, which would seem 
to indicate some increase in rates since 1900. 

In 1910 the railway companies, both in the East and in. the 
West, asked the Interstate Commerce Commission to sanction 
a general increase in freight rates. This it refused to do. In 
1 9 14, a renewed request for permission to increase rates on the 
part of Eastern carriers was at first denied but later granted. 
In 191 5 an advance in rates on a long list of commodities was 
proposed by carriers in the Middle West. The commission 
permitted certain of the advances proposed and denied others. 
Railway representatives assert that rates should increase when 
prices generally are increasing, but they have failed to demon- 
strate any general increase in their own ''cost of living"' except 
in the higher rates of wages paid and the higher rates, of interest 
recently prevailing. In the years following 1908, passenger 
rates were radically reduced in many states by two-cent fare 
laws. The average revenue per passenger per mile had shown 
little change prior to that time since the early nineties, when 
it was somewhat higher. Recently Eastern railways have 
also made general increases in passenger rates. A joint com- 
mittee of Congress recommended in 19 14 that the payments 
to railroads for carrying the mails be increased. 

These general changes or proposed changes in rates and fares 
give renewed interest to the question of how a reasonable rate 
may be determined.^ 

1 It is left as an exercise for the student to draw charts of the movement of rev- 
enues per ton per mile and per passenger per mile from the Statistics of Railways 
published by the Interstate Commerce Commission, and to compare at different 
dates the average length of haul and the proportions of various kinds of commodities 
carried. But it must be remembered that the average revenue per ton per mile 
is a single figure representing the result of applying an almost infinite variety of 
specific rates under varying traffic conditions. This is at once the advantage and 
defect of an average. To emphasize this point the average receipts per ton per 
mile are given in the following table for eight selected commodities by geographical 
districts. The average length of haul as given in this table is obtained by dividing 
the tons per mile by the number of tons carried, as reported by each railroad, in- 



TRANSPORTATION ECONOMICS 



565 



The Level of Rates. — If, owing to the monopolistic nature of 
the railway business, the determination of rates can no longer be 
left to the automatic working of competitive forces, they must 
be consciously determined according to fundamental principles. 
Competition was supposed to do justice by limiting the aggregate 
earnings of an establishment approximately to the expenses of 

eluding both the tons originating on the line of the carrier and the tons received 
from connecting carriers. The average haul, therefore, is the average haul on one 
railroad and not the average haul for the railroads regarded as one system. 
For all commodities taken together in ig.13 the average haul of a ton on one rail- 
road was 147 miles as against 260 miles for all the railroads regarded as a system. 
This last figure is obtained by dividing the ton-miles by the number of tons re- 
ported as originating on carriers' lines, excluding the tonnage received from con- 
necting carriers. The same correction cannot be made for the individual com- 
modities. The following table, it may also be noted, does not cover all of 
the mileage of the country, as many railroads do not compile traffic statistics in 
this form. 

Average Receipts per Ton per Mile and Average Length of Haul for 
Selected Commodities in Carload Lots for Year ENDrac June 30, igi3. 
Covering 151,941 Miles of Road 

(From Statistics oj Railways in the United States, 1913, p. 44.) 



District and Item 

COVEEED 





< 


2; 



u 




m 

w 
> 




w 

H 





OS 


Eastern District 


















Receipts per ton-mile 

— cents 
Length of haul — miles 


0.375 
262 


0.851 
158 


0.538 
252 


0.842 
228 


0.893 
327 


0.571 

170 


0.417 

126 


0.623 
148 


Southern District 


















Receipts per ton-mile 

— cents 
Length of haul — miles 


0.620 
250 


0.938 
193 


1.927 
179 


1.723 
138 


1.043 
255 


0-5SS 
119 


0.403 
180 


0.734 
161 


Western District 


















Receipts per ton-mile 

— cents 
Length of haul — miles 


0.740 
236 


I-IS5 
162 


1.792 
230 


1-397 
2og 


1. 106 

327 


0.630 
173 


0.676 

117 


0.713 
200 


Total — All Districts 


















Receipts per ton-mile 

— cents 
Length of haul — miles 


0.581 
248 


1. 005 
166 


1.693 
214 


1.258 
209 


0965 
323 


0.578 
170 


0.447 
135 


0.701 
176 



566 OUTLINES OF ECONOMICS 

doing the business, and it seems most natural that we should ap- 
ply the same standard in our railway rate making. There can be 
no doubt but that expense is a safe guide so far as it can be ac- 
curately determined. It needs but a slight analysis of railway 
expenditure, however, to reveal the difficulty of using expense as 
a criterion of a fair rate. In 1 9 1 3 the railways reported to the In- 
terstate Commerce Commission operating revenues and other in- 
come amounting to 3297 millions of dollars, and in this same year 
the interest on funded debt and dividends amounted to 666 mil- 
lions, or 20. 2 per cent of the revenues and other income. This rep- 
resents the amount accruing to the stock and bondholders as joint 
owners of the business, not counting the increase in surplus. Is 
this a proper payment to such owners ? That some compensa- 
tion of this sort is necessary under the regime of private capi- 
talism is clear, for if none were made, new roads would not be 
built nor would old ones be maintained. A common answer is 
that the owners should be allowed a fair return upon their 
investment, but it is difficult to say what is a fair return and what 
is the actual investment. The rate of interest to be allowed 
must be determined from a study of the investment market and 
from a consideration of what is necessary to provide a surplus 
for the lean years and for unproductive improvements. 

A more perplexing question is to decide upon a fair valua- 
tion upon which the return is to be calculated. Neither the 
amount of stocks and bonds nor the ledger value of the prop- 
erty is a safe guide. In some cases the actual investment may 
be traced historically where the records have not been destroyed, 
but this raises a series of difficulties. Was the investment 
wisely made, or does it contain a large profit paid to some con- 
struction company? Should investments made out of income 
or surplus be distinguished from the original investment or from 
proceeds of the sale of stock and bonds? The difficulty of as- 
certaining the full history of the investment has led to estimates 
of the cost of the production or reproduction of an enterprise 
by means of an engineering survey of the road and equipment. 
The Interstate Commerce Commission, through its Division of 
Valuation, has been engaged on the gigantic task of making 



TRANSPORTATION ECONOMICS 567 

a valuation of the entire railway system of the United States. 
Expensive as this undertaking is, it seems to be the only hope 
of reaching an equitable determination of what is to be regarded 
as a fair valuation upon which to base rates. Should the people 
of the United States ever reach the conclusion that it is wise 
for them to own the railways, a valuation of this kind, kept 
up to date by appropriate accounting, will be of the greatest 
benefit. But the " physical " or engineering valuation itself 
will not answer the question of what is a fair value. Shall the 
"cost new" or the "depreciated value" be taken? To what 
extent shall an intangible or " going " value be recognized? 

No answer of universal application can be given to these ques- 
tions, but it may safely be said that when a depreciation fund 
has been accrued through annual charges to operating expenses, 
the amount of such depreciation must be deducted from the 
cost new. It is sometimes said that if we deduct depreciation 
we must also add appreciation, but this is taken into account in 
the method by which valuations are usually made, that is, where 
real estate is valued according to the selling price of neighboring 
lands. It is extremely doubtful whether any going or intangible 
value should be recognized. To do this might amount to re- 
warding a railroad for becoming a monopoly. The case is some- 
what different from that of a manufacturing establishment where 
its " good- will " may frequently be developed by superior skill 
in the face of competition. 

Relative Rates. — When the general level of rates has been 
determined we are confronted by the question of what should be 
charged for each particular shipment, and here we find the appli- 
cation of the principle of expense of still greater difiiculty and un- 
certainty. In attempting to say what it costs to carry a ton of 
coal a mile, we find that a large part of the expenditure is incurred, 
not for one specific kind of comm.odity, but jointly for many 
kinds. The roadbed, ties, and rails are maintained, not for 
coal cars alone, but for passenger trains as well. Even with the 
most careful bookkeeping it is possible to trace a direct causal 
connection between only a part of the expenses and specific 
portions of the traffic. It is possible to say that a certain traffic 



5'68 OUTLINES OF ECONOMICS 

requires a certain amount of extra labor and fuel, and causes a 
certain amount of wear and tear, and clearly such traffic should 
normally pay enough to meet these expenses at least, if we wish 
to prevent waste. But what shall be done with such joint ex- 
penditures as fall under the head of maintenance of way ? Shall 
they be charged to the freight or to the passenger services ? The 
prevailing opinion has been that the cost of carrying a specific 
shipment cannot be determined with sufficient accuracy for any 
useful purpose because the element of " joint expense " is said to 
be a prominent characteristic of the production of railway serv- 
ices. In 1894 the National Association of Railroad Commis- 
sioners and the Interstate Commerce Commission indorsed the 
view that railroads should not be required to separate the 
operating expenses of their freight and passenger services. Since 
that time there has been a great development among manufac- 
turing enterprises of what is known as cost accounting, which is 
concerned with the apportionment of the total expenses of a 
factory among its several products. This has been found use- 
ful both in matters connected with the fixing of prices and in 
determining the efficiency of the various departments of an 
enterprise. Statistics of this kind were also developed by some 
railway managements, but little use was made of them in de- 
termining rates. In 1907 the railroad commission of Wiscon- 
sin gave an impetus to railway cost accounting by its opinion 
in the case of Buel vs. C. M. and St. P. Railway, where the 
reasonableness of a passenger rate of three cents a mile had been 
questioned. A complete apportionment was made of the 
expenditures of this railroad between its freight and passenger 
services. In 19 14 the Interstate Commerce Commission recon- 
sidered the whole matter, and after a public hearing decided that 
in the future railways must report their operating expenses sepa- 
rately for freight and passenger services according to bases to 
be prescribed by the commission.^ 

Is there a sound theoretical basis for this newer development ? 
This is a controverted point in economic theory and a full dis- 
cussion cannot be given here. What has been said in Chapter 

1 In the AI alter of the Separation of Operating Expenses (30 1. C. C. Reports, 676). 



TRANSPORTATION ECONOMICS 569 

XI regarding constant and variable expenses and joint expenses 
of production should be reviewed in this connection. Within 
certain limits an increase in the volume of railway traffic results 
in a lower average outgo per unit of product because certain 
items, such as maintenance of way and the interest on the in- 
vestment in the roadway, do not grow as rapidly as the traffic, 
not to mention other economies. As railways can classify their 
traffic by commodities and points of origin and destination, it 
will pay to make low rates on traffic which would not otherwise 
be secured. But it is superficial to stop with the analysis at this 
point. As traffic increases the tracks and bridges are strength- 
ened and additional tracks are added. In the long run the 
amount of the investment is markedly aflEected by the volume of 
traffic; that is, in the long run there is a causal connection be- 
tween growth in volume of traffic and growth in maintenance 
and interest charges, and this is the theoretical basis for attempt- 
ing to distribute transportation and equipment expenses and at 
least a part of the maintenance and interest charges to specific 
services. As a matter of fact, over 70 per cent of all of the 
operating expenses can be 'directly assigned to freight service 
or to passenger service without arbitrary apportionments, when 
the accounting is arranged for that purpose, and a considerable 
part of the investment can also be directly assigned to one serv- 
ice or to the other. The kind of expenses which can be dis- 
tinguished as between freight trains and passenger trains can also 
logically be distinguished as between different classes of freight 
trains, so that the cost of hauling a trainload, a carload, or even 
a ton of freight a mile can be approximated. If any class of 
freight traffic or passenger traffic cannot bear the operating 
expenses and interest charges attributable to that class of traffic, 
it is not profitable traffic. 

It is worth noting that the variety of railway services is not 
nearly so great as might be imagined from the multiplicity of 
rates in existence. Freight transportation consists in moving 
a mass of material in freight cars, and from the cost standpoint 
it makes little difference whether we call the material sand, 
cement, or iron ore. The fact that commodities vary in bulk 



570 OUTLINES OF ECONOMICS 

as compared with their weight is not an insuperable difficulty in 
comparing their costs of transportation. Forty tons of coal 
can be loaded in one car while forty tons of bird cages might re- 
quire forty cars, but the train resistance caused by a car and 
contents in each case can be measured approximately. 

While greater emphasis may in the future be laid on the cost 
principle, rates will doubtless continue to be based to a very 
large degree on the principle of " charging what the traffic will 
bear." Whether because of past commercial developments or 
for reasons of public policy, some traffic will be carried at rates 
less than those indicated by cost considerations, and this means 
that other traffic will have to bear rates higher than those 
indicated by considerations of cost. Some of the expenses of 
every railroad, varying in some degree with its stage of develop- 
ment, may even in the long run be regarded as independent of 
the traffic, and such expenses should be distributed over such 
traffic as can best bear them. In the construction of freight 
classifications, the value of a commodity itself is given con- 
sideration as a measure of what the traffic can bear or of the 
" value of the service," but it is clear that this is not an exact 
measure. 

Distance. — A most perplexing factor in rate making is that 
of distance. In actual practice, distance has been to a very large 
degree ignored. For example, in group rates, the same charge 
is made to a common market from any point within a certain area, 
irrespective of the length of the haul. In the basing-point system, 
the rates to small towns in a certain region will not vary accord- 
ing to the distance from the point of shipment, but are found 
by adding together the rate to a railway center, called a basing 
point, and the local rate from this basing point to the small town, 
even though the town be nearer than the basing point to the 
original point of shipment. Again, goods brought from a for- 
eign country to a point in the interior may be given a rate lower 
than the domestic rate from the point of entry to the same point 
in the interior. Again, goods intended for export sent from Chi- 
cago to New York may pa,y less than those intended for use in 
New York. Goods are sent to San Francisco from New York 



TRANSPORTATION ECONOMICS 57 1 

for less than the rate from many points west of the Mississippi 
River to San Francisco. '^ These conditions have largely grown 
out of the competition of railways among themselves and with 
waterways. 

The fact that distance is one element in the expense of carriage 
suggests that it should be taken account of in making rates, 
although there are many circumstances which necessitate a de- 
parture from the rule of a strict mileage rate. The fact that 
terminal charges, for example, are the same for a long as for a 
short haul justifies a decrease in the total charge per ton mile as 
distance grows. The great advantage of following a schedule of 
rates based on distance is that it affords some basis, although not 
an absolute guide, for settling sectional disputes concerning 
relative railway charges. 

. Government Ownership or Government Regulation ? — With 
the decline of competition in the railway business, the alternative 
lies between private operation with government supervision on 
the one hand, and government ownership and operation on the 
other. There cannot be said to be any well-defined movement 
for government ownership in the United States. Socialists favor 
it as a step in the direction of their ideals, but conservative 
persons also have recognized that the difficulty of regulating 
railroads with sufficient stringency to prevent abuses and at the 
same time with sufficient freedom given to railway managements 
to develop their properties in the most efficient manner may 
make governnient ownership inevitable. 

No convincing argument for either side of this question can 
be made by comparing the quality of railroad service and the 
rates charged in countries that have government ownership with 
the service and rates of railways privately owned and managed. 
There is little question that government ownership is feasible 
in this country and that good service might be expected. Greater 
pains might be taken to consider public convenience, and labor 
conditions might be improved for the lower classes of employees. 

1 See City of Spokane v. Northern Pacific Railway Co., 21 I. C. C. 400 and 23 
I. C. C. 454; United States v. Union Pacific Railroad Co., 234 U. S. 405 ; Commod- 
ity Rates to Pacific Coast Terminals and Intermediate Points, 32 I. C. C. 611. 



572 OUTLINES OF ECONOMICS 

Personal discrimination might be expected to cease altogether. 
It has been suggested that rates could be reduced because, owing 
to the superior credit of the United States government, capital 
could be secured at a lower rate of interest. But it is difficult 
to tell to what extent the credit of the government might be 
adversely affected by the issue of sufficient bonds to purchase 
the railways of this country. There might be economies in the 
elimination of some of the expenses due to the efforts of railways 
to get traffic away from each other, to roundabout hauls, and to 
useless duplication of facilities. 

The political consequences might be unfavorable. It would 
be unfortunate to have sectional disputes as to rates thrown 
into politics. Railroad extensions might become " pork," like 
our river and harbor improvements. The voting power of 
railway employees might be sought by politicians by promises 
of improved conditions of work. 

A most serious consideration is the question of efficiency of 
management. A private and a public monopoly alike may be- 
come unprogressive. It may be that our system of regulation 
can be so developed that it will serve at once as a check upon abuses 
and as a stimulus to efiiciency. It is not always best to decide 
today what can as well be decided tomorrow. • Whether or not 
government ownership is coming, the perfection of the govern- 
ment control of our private railways would seem to be the wisest 
next step. Government regulation has already accomplished 
much in the United States. It has nearly eliminated rebates 
and personal discrimination ; it has given stability to rates ; it 
has strengthened railway credit ; it has promoted uniformity in 
accounting ; it has shown that it can raise rates as well as lower 
them and that it can settle sectional disputes as to rates in a com- 
prehensive way. There still remains the task of determining the 
amount of railway investment entitled to a return, of devising 
a proper control over capitalization, of perfecting the rate 
system, and of working out comparative standards of effi- 
ciency. We may well hope that government ownership will at 
least be deferred until more has been accomplished along these 
lines. 



TRANSPORTATION ECONOMICS 573 

Government Regulation of Railways in the United States. — 

Railway corporations in the United States are almost all organ- 
ized under the laws of the separate states. Formerly special 
laws were passed when a railway company was to be formed, but 
at the present time there are general laws specifying what con- 
ditions must be complied with in order that a number of persons 
may organize a railway corporation. The separate states have 
imposed a number of regulations and restrictions not only on the. 
companies which they have chartered but also on others doing 
business within their borders. These relate to the safety and 
the comfort of passengers, train service, consolidations, pooling, 
ticket-scalping, discriminations between shippers and places, 
the issue of securities, and reasonableness of charges. Railway 
or public service commissions are found in all but a few states. 

That a railway corporation is subject to government regulation 
in the interest of the public welfare has been clearly established 
by a long line of judicial decisions beginning with the leading 
" Granger " case of Munn vs. Illinois} But the authority of 
the state governments has been greatly limited by two provisions 
in the federal Constitution. Congress having been given control 
over interstate commerce, the states must confine themselves in 
their regulations to commerce wholly within the state. And 
the Fourteenth Amendment declares that no state shall deprive 
any person of life, liberty, or property without due process of law 
or deny to any person within its jurisdiction the equal protec- 
tion of the law. The courts have interpreted this provision to 
mean that neither a state legislature nor a commission created 
by it can fix rates even on w/rastate traffic without a review by 
the courts. The courts have often declared rate legislation by 
states void on the ground that it confiscated the property of the 
stockholders.^ 

Federal regulation of railways is based on the Interstate 
Commerce Act of 1887, which has been repeatedly amended, 
most extensively in 1906 and 19 10. The following is a summary 
of the amended act, as in force in 1916 : 

1 94 U.S. 113(1876). 

2 The Fifth Amendment imposes similar limitations upon the federal government. 



574 OUTLINES OF ECONOMICS 

The Interstate Commerce Commission consists of seven mem- 
bers appointed by the President with the " advice and consent " 
of the Senate, with terms of seven years, not more than four of 
the commissioners being from the same political party. The 
jurisdiction of the commission extends not only over steam rail- 
ways but also over electric railways, telegraph, telephone, and 
cable companies, pipe lines, express and sleeping car companies, 
and to some extent over water carriers. The control in these 
cases extends to interstate traffic merely. 

All charges and practices must be reasonable, but no general 
standards of reasonableness have been prescribed by Congress. 
Certain specific things are prohibited. There can be no dis- 
crimination between persons or places and no free passes or free 
transportation except to classes of persons specified in the act. 
The giving of rebates renders both shipper and carrier liable 
to punishment. Pooling is prohibited, and no railway may 
have any interest in any competing water carrier. When rates 
have been reduced to meet water competition they may not 
be raised again without permission. No common carrier may 
make any greater charge for a shorter than for a longer dis- 
tance in the same direction, the shorter being included within 
the longer, unless authorized to do so by the commission. 
Carriers must file with the commission copies of all their rates 
and fares, and no carrier may make charges different from these 
published rates. Changes in rates require thirty days' notice 
unless a shorter time is permitted by the commission. The 
commission may suspend rates for a period of 120 days and a 
further period of six months. 

Any person may make a complaint regarding rates or prac- 
tices and the commission may institute inquiries on its own mo- 
tion. It has power to fix maximum rates for a period of two 
years and may award reparation to shippers who have been 
overcharged. The orders of the commission may be reviewed 
by the courts as to questions of law but not as to findings of fact. 
A Commerce Court was created in 19 10 to hear appeals from the 
commission's orders but this court was abolished in 1913, its 
jurisdiction being vested in the several district courts. 



TRANSPORTATION ECONOMICS 575 

Section 20 of the act empowers the commission to require 
annual and special reports from transportation companies and 
to prescribe the form of the accounts which may be kept. Under 
this provision uniform classifications of accounts have been 
worked out in cooperation with railway accountants. 

In 19 13 Congress directed the commission to ascertain the 
value of all the property of every common carrier subject to the 
act. As to every piece of property there is to be ascertained 
the original cost to date, the cost of reproduction new, the cost 
of reproduction less depreciation, and other values, if any. In 
1 9 14 the commission was given authority to enforce the Clayton 
Anti- trust Act so far as it applies to common carriers. The 
main purpose of this part of the act is to prevent those inter- 
corporate relationships which tend to lessen competition. 

The commission is also charged with the enforcements of 
safety appliance and boile: inspection provisions and with 
matters relating to hours of service of employees and to railway 
accidents. 

The Interstate Commerce Commission regularly employs about 700 
persons, but the work of valuation has temporarily greatly increased this 
number. A general survey of its work each year is given in its Annual Report 
to Congress. Its 30 or more volumes of decisions, published as the Inter- 
state Conunerce Commission Reports, contain a vast amount of descriptive 
material concerning the rate structures and the practices of railways in the 
United States. Information concerning the mileage, capitalization, reve- 
nues, expenses, and traffic of railways will be found in its annual volume called 
Statistics of Railways in the United States. 

QUESTIONS AND EXERCISES 

1. Write a description of some railway system, giving its organization, 
capitalization, earnings, dividends, nature of traffic, territory covered, etc. 

2. Make a digest of the opinions in the Northern Securities Case, 193 
U. S. 197, and the United States vs. The Union Pacific Railroad Company, 
226 U. S. 61. 

3. If you have paid $200 for a share of stock in a monopolistic enter- 
prise, have you a right to complain if government regulation so affects its 
earnings that the price of the share falls to $100? 

4. Discuss the conflict of authority between state and federal commis- 
sions (Shreveport Cases, 234 U. S. 342). 



576 OUTLINES OF ECONOMICS 

5. Can one ascertain what it costs the railways to carry United States 
mails ? 

6. Can the passenger service be said to be a by-product of the freight 
service ? 

7. Compare some of the leading railways from the standpoint of density 
of traffic. 

8. What would be the economic effects of a "postage-stamp " railway rate 
system, in which rates vary with the weight and nature of the shipment, 
but not with distance ? 

REFERENCES 

AcwoRTH, W. M. Elements of Railway Economics. 

Bureau of Corporations. Report on Transportation by Water, 1909, 1910. 

Hammond, M. B. Railway Rate Theories of the Interstate Commerce Commis- 
sion. 

Interstate Commerce Commission. Annual Reports ; I. C. C. Reports; 
Statistics of Railways in the United States. 

Johnson, E. R. American Railway Transportation ; Ocean and Inland 
Water Transportation : Report on Panama Canal Traffic and Tolls. 

Johnson, E. R., and Huebner, G. G. Railroad Traffic and Rates (2 vols.). 

Joint Committee on Federal Aid in the Construction of Post Roads. Re- 
port (1914). 

McPherson, L. G. Railroad Freight Rates in Relation to Industry and 
Commerce. 

Meyer, B. H. Railway Legislation in the United States, Part ii. 

Morris, Ray. Railroad Administration. 

MouLTON, H. G. Waterways versus Railways. 

National Waterways Commission. Report (1909). 

PiGou, A. C. Wealth and Welfare, Chap. xiii. 

Ripley. W. Z. Railroads: Rates and Regulation; and (editor) Railway 
Problems. 

Sakolski, a. M. American Railroad Economics. Chap. iii. 

Smith, J. R. The Ocean Carrier. 

Vrooman, C. S. American Railway Problems. 

Webb, W. L. Economics of Railroad Construction, Part i. 



CHAPTER XXVIII 
INSURANCE 

Nature of Insurance. — The essential idea of the modern in- 
stitution of insurance is cooperation in the bearing of losses which 
are likely to happen to any one of a large group of persons but 
which will actually fall upon but few members of the group. It 
is thus directly opposed to gambling, although wagers have fre- 
quently been made in the form of the insurance contract. It 
may appear at first that the man who insures his house is 
making a wager with the insurance company that his house will 
burn, but this is in fact like betting on both sides of an event. 
If the man does not insure, he may be regarded as betting that 
his house will not burn, and by wagering with the insurance com- 
pany that it will burn, he relieves himself of risk. For this relief 
he is willing to incur the certain loss of his premium. Insurance 
does not free the policy holders from loss, but it means many 
small losses in place of a few unbearable ones. In well-devel- 
oped forms of insurance there is also no risk for the insurance 
company, because the amount of loss is approximately known in 
advance, as will be explained presently. 

The question is sometimes asked whether insurance is pro- 
ductive in the sense that other economic activities are productive. 
The answer is decidedly in the affirmative, for the feeling of 
security that it makes possible is a real satisfaction which we are 
willing to purchase. Then too, there is a very important eco- 
nomic gain in distributing among many persons the burden of 
losses which would otherwise fall heavily upon a few. Further- 
more, the relief of distress among the unfortunate without com- 
pelling them to accept charity is a distinct social gain, and 
finally, many of our business operations are facilitated by the 
2 1* 577 



578 OUTLINES OF ECONOMICS 

existence of a system of insurance. Prevention of loss is not 
properly a part of the idea of insurance, but nevertheless insur- 
ance as it exists today does have many tendencies in that 
direction, especially in such forms as fire and steam-boiler in- 
surance. On the other hand, insurance causes a certain amount 
of loss by provoking to some extent incendiarism, self-mutilation, 
or suicide, and even normal persons are likely to be less careful 
when they know they are insured. On the whole, however, we 
can scarcely overestimate the importance to society of an in- 
stitution which equalizes economic shocks and multiplies the 
incentives to thrift. 

The Law of Probabilities. — A special profession (that of the 
actuary) and a special branch of mathematics have grown up as 
a basis of the institution of insurance. It is a knowledge of the 
law of large numbers that changes insurance from a wager to a 
business of a routine-like nature. If a coin is tossed a large num- 
ber of times, heads will appear about as often as tails. This may 
be counted upon as practically certain, but with respect to any 
particular throw taken by itself, there is no way of telling in ad- 
vance whether heads or tails will appear. This truth has been 
worked out and applied most definitely to life insurance, but in 
other business callings also an effort is made to gather data that 
will make possible the formulation of statistical laws as guides 
in making business plans. 

Origin and Development. — Arrangements embodying the 
idea of insurance are found among the ancients, but the modern 
institution of insurance, although its origin is obscure, first be- 
comes prominent in the loans on bottomry which became com- 
mon during the thirteenth and fourteenth centuries. A loan on 
bottomry meant that money was borrowed by the owner of a ship 
and was to be repaid with interest at the termination of his 
voyage, but the principal and interest were not to be repaid if 
the ship was lost. Sometimes this took the form of insuring 
the captain's life, but no scientific system of life insurance ap- 
peared until the compilation of life tables. 

Fire insurance received an impetus from the Great Fire of 
London in 1666, the first company organized upon strict mer- 



INSURANCE 579 

cantile principles being the " Fire Office," organized in 1680. It 
had a brigade of its own to prevent and extinguish fires. In 
1693 Edmund Halley made a report to the Royal Society regard- 
ing the mortality at various ages upon the basis of tables of 
births and funerals at the city of Breslau ; but, practically, life 
insurance as a business dates from the organization of the " Old 
Equitable " in 1762. 

Before this, however, there were many associations for conducting in- 
surance upon a speculative basis, which entered into wagers of every con- 
ceivable description. "Even the morality of the newspapers of that day 
was shocked by such proceedings: we find the London Chronicle of 1768 
thus declaiming, 'The introduction and amazing progress of illicit gaming 
at Lloyd's Coffee-house, is among others, a powerful and very melancholy 
proof of the degeneracy of the time. Though gaming in any degree is per- 
verting the original and useful design of that Coffee-house, it may in some 
measure he excusable to speculate on the following subjects: — Mr. Wilkes 
being elected member for London ; which was done from 5 to 50 guineas 
per cent.; — Mr. Wilkes being elected member for Middlesex, from 20 to 
70 guineas per cent ; — Alderman Bond's life /or one year, now doing at 7 per 
cent ; — On Sir J. H. [mark the modesty] being turned out in one year, now 
doing at 1 2 guineas per cent ; — On John Wilkes' life for one year, now 
doing at five per cent. N.B. — Warranted to remain in prison during that 
period ; — On a declaration of war with France or Spain in one year, 8 
guineas per cent. But,' continues the sensitive journalist, 'when policies 
come to be opened on two of the first peers in Britain losing their heads 
at los. 6d. per cent, or on the dissolution of the present parliament within 
one year at 5 guineas per cent., which are now actually doing, and under- 
written chiefly by Scotsmen, at the above Coffee-house, it is surely high time 
to interfere.'" ^ 

In the United States, fire insurance was fairly well begun 
even in pre-revolutionary days. In 1830 the New York Life 
and Trust Company was organized, and twelve years later ap- 
peared the Mutual Life Insurance Company of New York, 
which is the oldest of the existing American life insurance com- 
panies which insure more than a restricted class of individuals. 
In the seventies numerous failures brought the " old line " life 
insurance companies into discredit, and in the following years 
this fact, together with the desire for cheap insurance, caused 

1 Walford, The Insurance Guide and Handbook, 4th ed., p. 27. 



580 OUTLINES OF ECONOMICS 

a marked development of assessment insurance, against which 
there has in turn been a reaction because of its unscientific basis. 
Subsequently the " old line " companies again suffered a loss of 
prestige on account of the scandalous extravagance and corrup- 
tion revealed by official investigations. The evil practices had 
to do chiefly with the management of the surplus, which was not 
under legal control as was the reserve. (These terms will be ex- 
plained presently.) The accompanying table shows the growth 
in American life insurance since 1850. The check in 1880 may 
be noted. Between 1890 and 1910 the total amount of life in- 
surance in force in ordinary and industrial companies increased 
fourfold. The average amount in force per family was $319 
in 1890 and $801 in 1910. It is perhaps needless to state that 
the average amount per policy is much larger than this in 
ordinary though not in industrial insurance. The foregoing 
does not 'include the insurance fraternal orders, which had 
10,122,169 certificates and $9,839,909,282 of insurance in force 
in 1911. 

Forms of Insurance Organization. — Fire insurance may be 
written by stock companies, by mutual companies, or by associa- 
tions of individual insurers, known as underwriters and Lloyds. 
Mutual companies, again, may be either local (county or town) 
mutuals, state or general mutiials, or the manufacturers' mutuals. 
The local town mutuals have the advantage that they can be 
conducted with a very low cost of administration, but the stock 
companies seem best adapted to the business of fire insurance, 
since it is desirable that the risk of a conflagration should be 
spread over a very wide territory. 

Life companies are also found both in the stock and mutual 
form. Theoretically the management of the latter is in the 
hands of the policy holders themselves, but in actual practice 
they must be managed by a small group of financiers. Life in- 
surance companies are also classified according to the plans of 
premium payments : (i) " old line " level premium, (2) assess- 
ment, and (3) stipulated premium. 

Where risk enters in modern life, companies are often organized 
to offer an escape from it through insurance even before enough 



INSURANCE 



581 



data have been collected to make possible the accurate predic- 
tion of the amount of loss. In addition to life insurance we have 
indemnity in case of sickness, accident, destruction by fire, 
wind, hail, or explosions of boilers or fly wheels, broken windows, 

Ntjmber of Policies and Amount of Life Insurance in Force in 
Ordinary and Industrial Companies, 1850 to 1912I 



Ordinary 


Industrial 


Calendar 
Year 


Number of 
Policies 


Amount (Dollars) 


Number of 
Policies 


Amount (Dollars) 


1850 


29,407 


68,614,189 


— 


— 


i860 


60,000 


180,000,000 





— 


1870 


839,226 


2,262,847,000 


— 


— 


1880 


685,531 


1,581,841,706 


236,674 


20,533,469 


1890 


i,3i9'56i 


3,620,057,439 


3,882,914 


4^28,789,342 


1895 


1,940,94s 


4,917.694,131 


6,952,794 


820,746,562 


1900 


3,176,051 


7,093,152,380 


11,219,296 


1,468,928,342 


1905 


5,621,417 


11,054,255,524 


16,872,583 


2,309,754,235 


1910 


6,954,119 


13,227,213,168 


23,044,162 


3,179,489,541 


1912 


8,159,103 


15,555,901,171 


26,521,655 


3,684,054,893 



and loss from burglary or the unfaithfulness of employees. Li- 
ability insurance in over a dozen different forms guards against 
loss from damage suits. It is impossible to take up the problems 
that are peculiar to each one of these branches, and attention will 
be confined to some of the leading features of life insurance and 
of what is called social insurance. 



Life Insurance 

Life Tables. — A life table or mortality table shows how many 
of a large group of persons of the same age will survive to each 
higher age. A number of these tables have been calculated, 
but the one generally used in this country is the American Ex- 
perience table, a portion of which is here reproduced : 

1 Statistics from the Insurance Year Book. 



582 



OUTLINES OF ECONOMICS 



Age 


Living at Beginning of Year 


Dying during the Year 


lO 


100,000 


749 


II 


99,25^ 


746 


12 


98,505 


743 


13 


97,762 


740 


14 


97,022 


737 


15 


96,285 


735 


16 


95,550 


732 


17 


94,818 


729 


18 


94,089 


727 


19 


93,362 


725 


* 


* 


* 


90 


847 


38s 


91 


462 


246 


92 


2X6 


137 


93 


79 


S8 


94 


21 


18 


95 


3 


3 



With such data and with an assumed rate of interest and ex- 
pense, it is possible to say with considerable certainty how much 
money must annually be collected from the policy holders in 
order to pay each one $1000 or other specified sum at death. 

Premium Plans. — It would be possible to collect from those 
surviving at each age enough money to pay for the deaths that 
would happen during the ensuing year. This step rate or natural 
premium plan necessitates a larger and larger assessment with 
advancing age ; that is, as the earning power of the insured is 
declining. This induces many persons who continue in good 
health to discontinue their insurance, thus leaving only an " ad- 
verse selections of risks " for the insurance company or associ- 
ation. It has become customary to arrange the payments on 
what is known as the level premium plan, the same annual pay- 
ment being made throughout the life of the policy. This pay- 
ment may be on the ordinary life plan, that is, the payments 
continue throughout life ; or ten, fifteen, or twenty limited pay- 
ments may be made, the policy continuing in force for life; 



INSURANCE 583 

or the insurance may be for only a term of years during which 
the premiums are paid, the insurance ceasing entirely at the 
end of the term. This is the cheapest kind of insurance, for 
the insurance company knows that many of the insured will 
survive beyond the term, and to them no payment need be 
made, but when the insurance continues for life, the payment 
becomes a certainty in every case. 

The Reserve. — If a level premium is charged, the income of 
the company in the earlier years of a policy exceeds the expense 
of carrying the risk, as measured by the losses on account of the 
deaths among the policy holders of like age. The portions of the 
premium not currently used must be held for the credit of the 
policy holder until the later years, a certain rate of interest being 
allowed. This accumulating fund is known as the reserve. In 
the later years of the life of a policy, the reserve is gradually 
drawn upon to meet the deficit arising from the fact that in 
these years the level premium payments will be insufficient to 
meet the cost of carrying the risk, — smaller, that is, than they 
would have been under the step rate or natural premium plan. 

Surplus. — If the insured live longer than was assumed by 
the company in calculating its premiums, more money will be 
collected than is necessary to meet the obligations of the insur- 
ance contracts. This is one source of surplus. Again, the 
funds held in trust by the company may be invested at a higher 
rate of interest than was assumed in the calculations, and this is 
a second source of surplus. A third source of surplus is in keep- 
ing expenses below what was assumed in the calculations. (The 
addition which is made to the net premium to cover expenses is 
called "loading," and is commonly not far from a fourth of the 
gross premium.) The amounts paid in by those who subse- 
quently lapse or surrender their policies do not all go to the 
surplus, for it is customary now to allow "surrender values" 
and "paid-up insurance " ; but as these allowances are subject 
to a surrender charge, there is some addition to the surplus 
from the surrendered or lapsed policies. Out of the surplus are 
paid the dividends on the capital stock, if there be any,, and 
the dividends to each policy holder, which in some cases are 



584 OUTLINES OF ECONOMICS 

credited or paid annually to each policy holder, but in other 
cases not until the expiration of a period of years. . 

Endowments. — What is ordinarily called an endowment 
policy is a combination of two distinct forms of contract. A 
simple life insurance contract promises to pay a certain sum 
upon the death of the insured ; a pure endowment contract would 
pay a certain sum if the holder of the policy survives after a 
period of years. A twenty-year endowment insurance policy 
combining these two features means that payment would be 
made at death if that occurred within the twenty years, or at the 
expiration of twenty years if the policy holder survives. 

This form of policy has been declining in popularity because 
in its ordinary form it is disadvantageous to the policy holder, 
unless he be so thriftless that he cannot be induced to save in any 
other way. If insurance could not be obtained in any other 
way, it might be wise to purchase such a policy, but the- objects 
of saving and insuring can be more cheaply accomplished by 
separating the two features. If, instead of paying $50 for an 
endowment policy , the holder paid part of this for term insurance 
and put the remainder in a savings bank at three or four per cent 
Compound interest, there might be more to his credit whether 
he lived or died. But when the loading is properly arranged, 
and v/ith an annual distribution of surplus, the endowment policy 
performs a useful function as an encouragement of thrift. In 
fact, a very long-term endowment maturing at, say, age sixty- 
five, would best meet the needs of a great many persons. Many 
others, feeling that they lack the necessary determination to save 
regularly a portion of their incomes in the ordinary way, find 
the endowment policy a useful form of " compulsory saving." 

These points will be made clearer by the following illustration 
of what becomes of the premium in the case of a ten-year endow- 
ment policy at age thirty-five with a premium of $107.70, when 
it is assumed that the mortality will be in accordance with the 
American Experience Table, that the company will earn three 
per cent on its funds, and that the expense charged each year to 
this policy will be as given in the table. ^ 

^ Report of the Wisconsin Joint Legislative Investigating Committee, 1906, p. 153. 



INSURANCE 



585 



Policy Year 


Expense Charge 


Mortality Charge 


Deposit 


I 


$ 18.40 


$7.96 


$ 81.34 




2 


18.40 


7-31 


165-77 




3 


18.40 


6.62 


253-42 




4 


18.40 


5-89 


344-43 




5 


18.40 


5.10 


438.96 




6 


18.40 


4.26 


537-17 




7 


18.40 


3-32 


639.27 




8 


18.40 


2.32 


745-43 




9 


18.40 


1. 21 


855-89 




10 


18.40 


— 


970.87 




Totals 


$ 184.00 


$43-99 





Industrial Insurance. — The business of insuring the lives of 
workingmen in this country is characterized by the small size 
of the average policy, the large number of lapses, and the heavy 
expense of solicitation. The companies say that the working- 
man is so thriftless that it is necessary to collect the premiums 
through a house-to-house canvass by agents. The hesitancy 
shown by workingmen to insure in these companies is considered 
by some persons, however, as an evidence of their thrift. Which 
is the correct view may be shown by the results of an experiment 
which is now being tried in the state of Massachusetts. Savings 
banks have been authorized to organize insurance departments 
and to sell life insurance, but without employing paid agents or 
solicitors. The state bears the actuarial, medical, and certain 
other expenses. The workingman is expected to go of his own 
accord to the bank or to one of the agencies at convenient places. 
The whole system is supervised by a state actuary and a state 
medical director, and the safety of the plan is assured by a guar- 
antee fund. Three forms of policies, limited to $500 each, are 
provided for : ordinary life insurance, endowment, and a com- 
bination of life insurance and old-age annuity. The plan has 
met with some success, but is still in an experimental stage. 

State Insurance. — Insurance is well adapted to direct man- 
agement by the State because the actual conduct of the business 



586 OUTLINES OF ECONOMICS 

is of a relatively simple and routine character and because the 
State can offer greater security and can command greater confi- 
dence than is possible in the case of a private corporation. Com- 
petition has had the effect of causing rival companies to invent 
many outwardly attractive combinations of policy conditions, 
but on the whole it has increased rather than decreased the ex- 
pense of doing the business. When the State enters the field 
simply as an additional competitor, as in New Zealand, its full 
advantage is not apparent ; but if it has a monopoly of the busi- 
ness and compels every one to insure, it can perhaps, without 
any selection of risks, effect the insurance at a lower price than 
is asked by any existing private company.^ In 1913 the state 
of Wisconsin began the sale of life insurance. The main object 
of the law is the reduction in the cost of insurance by reducing 
the expense of solicitation and administration. The credit of 
the state is involved only to the extent of the life fund created by 
the insurance act. In Italy life insurance is a state monopoly. 

State Regulation. — Following the example of Massachusetts 
in 1858, other states have appointed insurance commissioners 
for the supervision of this business, and the insurance laws of 
a single one of these states are now sufficient to make a good- 
sized volume. Insurance companies have found this variety of 
control irksome and have generally advocated federal control of 
insurance. Although something would be gained, it cannot be 
said that there is any great need of federal control of life insur- 
ance, not to mention the constitutional difficulties, because it is 
not absolutely necessary, as in transport or fire insurance, that 
one life company do business in many states, and the people of 
each state should have the power to say what kind of insurance 
institutions they desire to have. 

An enumeration of the requirements in the state of New York 
will illustrate the nature of state regulation : A certificate of 
authorization must be obtained from the Superintendent of In- 
surance and a deposit of securities must be made. A minimum 
capital stock is prescribed and regulations are made concerning 

1 Consult the article by M. M. Dawson in Bliss, Encyclopedia of Social Reform, 
new ed., p. 637. 



INSURANCE 587 

the investment of stock and surplus. There are also provisions 
relating to standards of solvency, reinsurance, limitation of risks, 
admission of foreign companies, examination of accounts, and 
annual reports. The policy must contain the entire contract, 
and the statements are to be taken as representations and not 
warranties. No misleading estimates and deceptive statements 
are to be issued for the purpose of getting business. Life insur- 
ance companies are to do either a participating or non-partici- 
pating business, and in the former case the surplus must be an- 
nually apportioned and paid to each policy. There are further 
provisions regarding the valuation of policies, surrender values, 
discrimination, election of directors, limitation of the amount of 
new business each year, limitations as to expenses and salaries of 
officers, and standard forms of policies are prescribed for both life 
and fire insurance. 

Social Insurance 

Social Insurance Defined. — Social insurance refers to those 
insurance or quasi-insurance institutions which are organized 
by the state to alleviate the distress which is likely to fall upon 
the poorer classes as a result of accident, sickness, invalidity, 
old age, unemployment, and the premature death of the chief 
wage earner of the family. All insurance is obviously social 
in the sense that it implies cooperation on the part of many 
persons and is subject to extensive state regulation, but what 
is called social insurance implies the activity of the state far be- 
yond mere regulation. It is true that private activity has done 
much in the direction of workingmen's insurance, but it is be- 
cause these efforts have proved inadequate that the movement 
for social insurance has gathered force. It is to be distinguished 
from poor relief in that it recognizes that the normally thrifty 
wage earner cannot purchase adequate life and accident insur- 
ance from private commercial companies and that the respon- 
sibility rests on society to provide that which it is impossible for 
the individual to provide. It endeavors by insurance methods 
to provide in advance for the coming of the evil day, so that the 



588 OUTLINES OF ECONOMICS 

benefits paid will be received, not as a matter of charity, but 
as a matter of right. 

Compensation for Industrial Accidents. — In the United 
States social insurance has begun its development in connection 
with the problem of industrial accidents. Under the common 
law, the employer is not responsible to an employee injured 
while at work if a reasonably safe place to work has been fur- 
nished. Even if the employer is at fault, there is no redress if 
there has been contributory negligence on the part of the em- 
ployee or one of his fellow servants or if the accident happens 
without negligence that can be traced to any particular person. 
This law of negligence has generally been modified by legis- 
lation designed to increase the responsibility of the employer, as, 
for example, by the restriction or elimination of the fellow ser- 
vant doctrine.^ While employees have sometimes been able to 
secure damages amounting to small fortunes, the general result 
of this legal system is that in the vast majority of cases only 
small damages or none at all are secured, or, if secured, they are 
in large part offset by the cost of litigation. The liability 
of the employer, however, is a serious matter to him, and an ex- 
pensive system of employers' liability insurance has grown up. 
The more severe the modifications in the law of negligence be- 
come, the higher are the rates imposed by the liability com- 
panies. Such is the expense of conducting this business that 
it is safe to say that less than one half of the money paid for em- 
ployers' liability insurance premiums ever reaches the injured 
employees in damages. While labor leaders were drafting bills 
designed to increase still further the liability of employers, 
attention was turned to European practice, where the view 
had come to prevail that it is useless to try to locate the 
responsibility for accidents, except for purposes of preventing 
them in the future, and that if a workman is injured in the 
course of his employment, he should be promptly assisted, even 
if he had been negligent. Accidents were looked upon as a 
trade risk against which the workingman should be adequately 
insured. 

^ See Chapter xxiii. 



INSURANCE 589 

The result was that in the years following 1910a wave of work- 
men's compensation legislation swept over our northern and 
western states. By the end of 1914 over one half of our states 
had enacted compensation for accident laws. The federal 
government had in 1908 established a system of compensation 
for industrial accidents for the majority of its industrial em- 
ployees. During the first five years of its operation $1,804,000 
was paid out as compensation, nearly one half of which was paid 
to employees of the Isthmian Canal Commission. The law 
did not abolish the criterion of negligence, as according to its 
terms accidents resulting from the misconduct or negligence 
of the injured person are not compensated. The amount of 
compensation is the injured workman's wages during disability, 
not exceeding one year, or in fatal cases, an amount equal to one 
year's wages. In other respects also the law does not conform 
to an ideal compensation law and efforts have been made to 
amend it.^ 

The provisions of the various state laws differ greatly in de- 
tail, but it may be said that in general they provide for definite 
payments to injured workmen in hazardous employments, prac- 
tically regardless of negligence and almost universally at the 
expense of the employer. In some states the law is compul- 
sory, that is, the employer engaged in the industries covered 
must pay the compensation specified and must insure himself 
against the liability. In other states the law is nominally op- 
tional, the employer and employee being free to remain under 
the old law of negligence, but an inducement is given to them to 
choose the new compensation method by providing that if either 
does not accept it, he is put to certain disadvantages under the 
law of negligence. The purpose of this roundabout method (not 
always successful) of securing compliance is" to overcome the 
difficulty that under our constitutional guarantees of freedom 
a direct compulsion might not be sanctioned by our courts, 
while the modification of the law of negligence is well established 
by precedent. 

The following are the standards (abridged) recommended by 

1 Bulletin of the Bureau of Labor Statistics, No. 155, p. 77. 



S90 OUTLINES OF ECONOMICS 

> 

American Association for Labor Legislation for workmen's 
compensation laws : ^ 

1. As to the scale of compensation: Medical attendance 
should be furnished. No compensation should be paid for a 
definite period at the beginning of disability, the period being 
not less than three nor more than seven days. The disabled 
workman should receive during total disability 66f per cent 
of wages, not to exceed $20.00 a week and not less than $5.00, 
In case of partial disability the compensation is based on loss 
of earning power. In case of death, the employer should be 
required to pay funeral expenses, and the widow, if living with 
the decedent at the time of his death, or if dependent, should be 
granted 35 per cent of his wages until her death or re-marriage, 
with a lump sum on re-marriage equal to two years' compensa- 
tion. Compensation may also be given to other dependents. 

2. The general argument for compensation applies to all 
employments, but practical considerations may justify the tem- 
porary exclusion of farm labor, domestic servants (except in 
connection with hotels and restaurants) and casual employ- 
ment not carried on for the profit of the employer. 

3. Compensation should be provided for all personal injuries 
in the course of employment, and death resulting therefrom in 
six years, but no compensation should be allowed where the 
injury is occasioned by the wilful intention of the employee 
to bring about the injury or death of himself or another. The 
act should embrace occupational diseases which, when con- 
tracted in the course of employment, should be considered 
personal injuries for which compensation shall be payable. 

4. Compensation should be the exclusive remedy; that is, 
the workman should not be given the option of bringing suit 
under the law of negligence. 

5. Employers should be required to insure their compensation 
liability. Employers may maintain their own insurance fund 
under certain conditions, insure in a mutual association, in a state 
insurance fund, or in a private stock company. 

6. An accident board should be maintained by the state, 

^American Labor Legislation Review, vol. iv, p. 585. 



INSURANCE 591 

the members of which should devote their entire time to the 
administration of the compensation law. 

7. Provision should be made for the settlement of compen- 
sation claims either by agreement subject to the approval of the 
accident board, or if no agreement is reached, by arbitration, 
with an appeal to the accident board. Appeals from the decrees 
of the accident board should be allowed only on questions of law. 

8. Provision should be made for full and accurate reports of 
all industrial accidents. 

Occupational diseases are not included by the compensation 
laws of the several states, although the Supreme Court of Massa- 
chusetts has construed such diseases to be injuries entitling the 
employee to compensation. In Michigan, however, the con- 
trary view has been taken. 

Sickness Insurance. — Compulsory sickness insurance has 
been introduced in about one half of the large countries of 
Europe and voluntary subsidized sickness insurance in others, 
but we have so far left practically everything in this direction 
to private effort, although there are state miners' hospitals in 
five states and the federal government conducts a hospital 
service for seamen. Many students of the subject believe that 
sickness insurance will never be made effective unless it is made 
compulsory. It is significant that Great Britain, where the tradi- 
tions, as in the United States, are against compulsion, made 
sickness insurance compulsory by the act of 191 1. The major- 
ity of workers, by virtue of being employed, are assured certain 
benefits in case of illness, the cost of the insurance being met 
partly by the government, partly by the employer, and partly by 
deduction from the employees' wages. In Germany, where a 
system of compulsory sickness insurance was established as early 
as 1883, one third of the cost is borne by the employers and two 
thirds by the employees. The sickness insurance benefits in 
that country cover also the care in whole or in part for the first 
thirteen weeks of those injured as the result of industrial acci- 
dents, after which time the accident benefits are paid wholly from 
accident insurance funds, and include maternity benefits, fu- 
neral benefits, and sometimes sick benefits for the members of the 



592 OUTLINES OF ECONOMICS 

family other than the insured. Maternity benefits were added 
in England by an amendment in 19 13. We have need for simi- 
lar laws in this country and the framing of such laws may be 
looked upon as the next step in social insurance here. 

Old Age Insurance. — We are familiar in the United States 
with a pension system growing out of past wars and with local 
pensions for firemen and policemen. Other countries have 
provided in a much more general way by pensions, subsidized 
voluntary insurance, or by compulsory insurance for the relief of 
persons incapacitated by old age. Invalidity and old age insur- 
ance is one of the three great branches of the German insurance 
system. It covers the great majority of the wage earners of 
both sexes. There are contributions in equal amounts by the 
insured workmen and their employers and a yearly addition is 
made to each pension by the government. The English law of 
1908, on the other hand, provides for a straight pension to per- 
sons 70 years of age or over whose incomes are below $153 a 
.year and who have not certain disqualifications mentioned in the 
act. The amount paid varies from 24 cents to $1.20 a week. 
The British system resembles poor relief more closely than insur- 
ance. For years an attempt has been made to induce the United 
States government to adopt an old age pensions system for its 
employees, but there has been radical difference of opinion as to 
whether such a system should be with or without contributions 
by employees. In this, as in the more general problem, a non- 
contributory pension may be the more advisable at the start, 
but a contributory old age insurance system is doubtless more 
desirable as permitting of more liberal incomes and as en- 
couraging thrift. 

Unemployment Insurance. — The solution of the problem 
of unemployment involves much more than insurance. The 
progress of industry should be made less irregular and men and 
opportunities for work should be brought together more readily. 
Attention is being turned at present in the United States to the 
establishment of a national system of labor exchanges. It is 
not to be expected, however, that unemployment can be elimi- 
nated. It is a misfortune which should be provided against by 



INSURANCE 593 

insurance. Many European cities have made experiments in 
this field which have left much doubt as to the practicability 
of insurance as a general remedy for the evil of unemployment. 
But the British National Insurance Act of 191 1 has instituted a 
great experiment which is tending to remove this doubt. By 
that act persons engaged in building, construction of railroads, 
docks, or canals, shipbuilding, iron-founding, construction of 
vehicles, and saw-milling are entitled to receive unemployment 
benefits. About a quarter of a million of persons are covered 
by the act. The cost of this insurance is met by contributions 
from employers and employees and partly from appropriations 
by Parliament. 

Life Insurance for Workingmen. — Our private life insurance 
companies are selling a good many policies which are pay- 
able, not as lump sums, but in installments or annuities, to the 
survivors of the insured. Wage earners cannot often afford to 
purchase such policies, but the same object is to some extent 
attained by widows' and orphans' pensions. Beginning with 
191 2 such pensions have been made a part of the German in- 
surance system. In the United States many state laws have 
recently been enacted providing for pensions to mothers in need 
of relief. While these American acts are to be viewed as a form 
of poor relief, they are significant as possible forerunners of a 
comprehensive system of workingmen's life insurance. 

Objections to Social Insurance. — Aside from questions of 
constitutional law, social insurance is met with the following 
difficulties : (i) It implies a considerable addition to the wages 
bill and it has been urged that it is unfair to place this burden 
on the employers of one state unless similar burdens are placed 
on employers of other states. (2) It is contrary to the eco- 
nomic philosophy of those who wish to see state activity reduced 
to a minimum. (3) It has been charged that social insurance 
discourages thrift and that it leads to demoralization because it 
encourages malingering and staying at home for trivial ailments. 
Cases are cited in which a maternity benefit was spent on liquor 
by the husband, and one man is said to have spent the maternity 
benefit in the purchase of a graphophone. It should be noted, 

2Q 



594 OUTLINES OF ECONOMICS 

however, that all insurance is subject to abuse. Who would 
question the beneficence of fire insurance because it leads in 
some cases to incendiarism? Fire insurance companies do a 
good deal in the way of fire prevention. Similarly, not the 
least important aspect of social insurance is its relation to the 
conservation of the national health. The employers' associa- 
tions in Germany organized for accident compensation have 
done much for accident prevention, and a system of sickness 
insurance gives timely medical and adequate care to many who 
now waste their money on patent medicines. 

QUESTIONS 

1. Define insurance. 

2. What is a mortality table? 

3. How would you find the premium for insuring a group of persons for 
one year for $1000 each? 

4. Distinguish between reserve and surplus. 

5. What is a "pure" endowment policy? 

6. What are the advantages and disadvantages of assessment insurance ? 

7. What has been New Zealand's experience with State insurance? 

8. What is meant by the "moral hazard"? 

9. What are tontine policies? 

10. Why is the " fellow-servant doctrine" not suited to modern con- 
ditions ? 

11. Discuss the possible effects of social insurance on wages. 

12. Are old-age pensions a form of insurance ? 

REFERENCES 

Alexander, William. The Life Insurance Company. 

American Labor Legislation Revieiv: "Social Insurance," June, 1913; 
" Sickness Insurance," March, 1914; "Unemployment," May, 1914. 

Annals of the American Academy of Political and Social Science, Vol. xxvi. 

Dawson, M. M. The Elements of Life Insurance; The Business of Life 
Insurance. 

Dawson, W. H. Social Insurance in Germany. 

FOEESTER, R. F. "The British National Insurance Act," Quarterly Jour- 
nal of Economics, Vol. xxvi, p. 275. 

Frankel, L. K. and Dawson, M. M. Social Insurance in Germany. 

Fricke, W. A. (compiler). Insurance — A Text-hook. 

Gephart, W. F. Insurance and the State; Principles of Insurance {Life). 

Gibbon, I. G. Unemploymejit Insurance, Chap. viii. 



INSURANCE 595 

Gow, William. Marine Insurance. 

HuEBNER, Solomon. Property Insurance; Life Insurance. 

Jack, A. F. An Introduction to the History of Life Assurance. 

Kitchen, F. H. The Principles and Finance of Fire Insurance. 

Massachusetts Commission on Old Age Pensions, Annuities, and Insurance. 

Report, igio. , 

MoiR, Henry. Life Assurance Primer. 

New York Insurance Investigating Committee. Report, 1905 (6 vols.). 
RuBiNOW, I. M. Social Insurance. 
Seager, H. R. Social Insurance. 
The Insurance Year Book, Annual (2 vols.) 
United States Bureau of Labor Statistics. Bulletin, Nos. loi, 102, 103, 107, 

109, 126, and 155. 
United States Commissioner of Labor. Twenty-fourth Annual Report. 
Walford, Cornelius. The Insurance Guide and Handbook. 
Wisconsin Insurance Investigating Committee. Report, 1906. 
Yale Readings on Insurance (2 vols.) 
Zartman, L. W. The Investments of Life Insurance Companies. 



CHAPTER XXIX 
AGRICULTURAL PROBLEMS 

The socialistic ideal of a highly centralized and delicately- 
coordinated industrial system, discussed in the following chap- 
ter, is confronted with a sharp contrast in the agricultural in- 
dustry as it exists to-day. Even in the most advanced coun- 
tries, agriculture is still strikingly decentralized, and furnishes 
at once the best illustration and the most fertile source of 
economic individualism. Even in this country, where the 
movement of industrial consolidation has proceeded with un- 
usual rapidity, agriculture has never been, and shows little 
tendency to become, a large-scale industry. The principal 
statistical evidence bearing upon this aspect of American agri- 
culture is presented in Table I, on the following page. 

Size of Farms. — So magnificent was the public domain of 
the United States that for many generations the number of 
farms increased more rapidly than the population and much 
more rapidly than the rural population. Between 1850 and 
1910, for instance, the number of farms increased more rapidly 
than the population in four of the six decades. But such a 
movement could not continue indefinitely, and in recent years 
the relative number of farms has slightly fallen off. Even to- 
day, however, as shown in the last column of Table I, there is a 
larger acreage of improved farm land per capita than there was 
in 1850, and despite the rapid increase of population between 
1900 and 1910, the increase in the amount of improved farm 
land almost kept pace. 

This steady increase in the number of farms and farmers could 
only have been maintained by a general diminution in the aver- 
age size of the farm. From 1850 to 1910 the average number 
of acres per farm decreased from 203 to 138, while the acreage 

596 



AGRICULTURAL PROBLEMS 



597 





w 




o 




<; 




fA 


1— 1 


^ 


w 


< 


1-1 


g 


< 


H 


H 


y, 








w 




o 




ih; 




-u 




w 




u 



Average 
PER Capita 

(based on 
total popu- 
lation) 


Im- 
proved 
land 
in 

farms 




M lo r>« J>. Ch c^ On 
lO lO uo liO tJ- uo ■<i- 


All 
land 

in 
farms 




m3 O OS r^ o O r^ 
c> H as d d fo <N 


k 

o a 


5| 


M 


o q IT) q 00 o t^ 

<N lO -^ ro <^ r^ CO 


Im- 
ple- 
ments 
and 
ma- 
chin- 
ery 


P) 


CO ro ro PO rO CO CO 




H 


III Ml 1 


Land 
and 

build- 
ings 


o 


On CO VO r^ M CO lO 

■rf- H (N CO CO CO pJ 
00 00 00 00 OO 00 00 


H 
Pi 

> 

i 

> 
< 


Imple- 
ments 
and ma- 
chinery 


« 


OS M 00 M M O >0 

0^ CO O O O C^ O 


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so so 
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•* CO CO 00 CO ■'t 00 
T^ so CM CO so O CO 

T)- vo uo q^ CO qs !>• 

scT CO CO CO CO CO cs" 


Average 
Number of. 

Acres 
PER Farm 


T3 

si's 


lO 


<N 0) CO O O OO O 

lO <N 00 M w 6s 00 

t^ r^ t^ r^ r- t^ t^ 


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Per 
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In- 
crease 

OF 

Popu- 
lation 

PER 

Dec- 
ade 


f) 


O t^ lo i-i so sq 

M 6 lO 6 CM lO 
P) CM CM CO Cq CO 


Per 
Cent 

In- 
crease 

of 
Farms 

PER 

Dec- 
ade 


N 


O^ r^ OS t^ M M 

6 i^) CO d 6 i-< 

M C< M to CO "* 


Number of 
Farms 


" 


CM IN M r-~ TO r^ CO 
O r^ •* O CO i^ f-» 

lo CO so Os OS o o 

m" r^ Tt OO 0< "* OS 
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OS OS 00 00 00 00 00 



598 OUTLINES OF ECONOMICS 

of improved land per farm has remained nearly constant. 
Since 1880 we have had detailed statistics for farms of different 
sizes. Farms of all sizes have been increasing, but the in- 
crease has been greatest for farms under 50 acres in size, the 
relative importance of which has increased steadily since 1880. 
The relative importance of farms over 50 acres in size has 
decreased. 

Broad statements of this kind cover a multitude of different 
movements and tendencies. Between 1900 and 1910, for in- 
stance, farms under 50 acres and from 175 to 1000 acres increased 
more rapidly than the total; whereas farms from 50 to 175 
acres, and those over 1000 acres in extent, increased less rapidly 
than the total. In the North, between 1900 and 1910, farms 
between 20 and 100 acres in size decreased both absolutely and 
relatively; all others, including farms over 1000 acres, gained 
in relative importance. 

In the South, farms smaller than 100 acres increased while 
"those over 100 acres in size diminished in relative importance. 
In the West the movement was substantially the same as in the 
South : farms under 100 acres in size increased while all those 
over 100 acres in size lost ground, comparatively speaking, 
except the class of farms containing from 175 to 449 acres, 
which showed a small relative gain. In the North, particu- 
larly in New England, there seems to be a real increase in the 
number and importance of the large farms, those which in cer- 
tain sections would be called " gentlemen's farms " ; but this 
is more than counterbalanced by the partition of plantations of 
the South and of the cattle ranges and bonanza farms in the 
West. 

Although the average farm decreased in size between 1900 
and 1910, there was a striking increase in the value of the aver- 
age farm and its equipment. In the last half of the nineteenth 
century no tendency towards the increase in capital value of 
the farm unit had appeared. The value of the total property 
and equipment of the average farm was actually lower in 1900 
than in i860; and the increase in the items of implements and 
machinery was quite in keeping with the rapid growth in wealth 



AGRICULTURAL PROBLEMS 599 

and income in the United States, particularly among agricul- 
tural laborers and farm population. But between 1900 and 
1910 the situation was, in appearance at least, transformed. 
As one commentator has aptly said, the selling price of farm 
property increased by a larger amount in the first decade of the 
twentieth century than it did in the entire period between the 
landing of Columbus and the close of the nineteenth century. 
The average value of all farm property per farm, as shown by 
Table I, rose frorii $3563 in 1900 to $6444 in 1910. The in- 
crease was greatest in the value of the land itself. In this 
decade the average value per farm of all farm property in- 
creased 80.9 per cent; that of land alone, 96.7 per cent; farm 
buildings, 60.3 per cent; implements and machinery, 51.9 per 
cent ; farm animals, including poultry and bees, 44.4 per cent. 

The full significance of this striking change is difficult to 
ascertain. In many respects is it more apparent than real and 
reflects merely the depreciation in the general purchasing power 
of the monetary unit. Thus, the average value of farm equip- 
ment per farm increased in a decade from $667 to $973, only 
45.9 per cent, hardly more than the general increase in prices 
throughout the country and probably no more than the aver- 
age income or ability of the typical farmer. So far as equip- 
ment is concerned it is probably no more difficult for the aver- 
age farmer to secure the required amount of equipment today 
than it was twenty years ago. But the total value of farm 
land has increased more than 100 per cent, and the value of the 
land in the average farm has increased nearly 100 per cent. 
The movement is real and exceedingly significant so far as 
land values are concerned. Prices of farm products have in- 
creased more rapidly than most other prices. This has re- 
flected itself in a rise in the value of farm land which is far 
greater than the rise in the general price level. It has become 
in many sections far more difficult than it used to be for the 
young farmer to secure a farm of his own, and in those districts 
tenancy has increased rapidly, while in many of them the popu- 
lation has actually declined. 

Technically speaking, therefore, there appears no significant 



6oo OUTLINES OF ECONOMICS 

increase in the size of the unit of agricultural industry. The 
farm unit is not growing in the physical or material sense in 
which the factory may be said to be growing. There is no 
consolidation or concentration such as we find in the manufac- 
turing industries. But the amount of capital represented by the 
farm unit has increased strikingly in the last few years and 
probably much more rapidly than the average wealth or in- 
come of the farm population.^ 

So much for the size of the farm as it is ; the next question 
concerns the size of the farm as it should be. Would the pros- 
perity of the agricultural classes and the general welfare be in- 
creased by expanding or reducing the farm unit, by m.ore or less 
intensive farming? 

Obviously no simple answer can be given to this question. 
The value of the land or the rent it will bring is perhaps the 
most important factor : high rental value indicates that the 
margin of cultivation has been forced to a comparatively low 
point, and makes it both necessary and profitable to work the 
land intensively, for the same reason that the owner of a very 
valuable manufacturing plant is inclined to run it night and 
day, if possible, in order to reduce that part of the cost of pro- 
duction which represents fixed charges or interest on the capital 
that is sunk in the enterprise. In addition to the factor of rent, 
the amount of capital that he can command, the kind of farm- 
ing in which he is most skilled, the character of the labor he can 
secure, the proximity of markets, and the adequacy of trans- 
portation facilities, all must be taken into account by the in- 
dividual farmer in determining how large a farm he will attempt 
to manage and how intensively he will farm it. 

Speaking generally, however, two powerful but counteracting 
forces can be detected in the agricultural industry, which pre- 
vent the industry from becoming either predominantly inten- 
sive or predominantly extensive. On the one hand, machinery 
can be employed most advantageously on a comparatively large 

1 "In recent years the value of farm lands has been increasing at the rate of about 
5 per cent a year, or approximately $2 per acre per year." Monthly Crop Report, 
vol. ii, No. 4 (April 15, 1916). 



AGRICULTURAL PROBLEMS 6oi 

farm, and, other things being equal, the use of labor-saving 
machinery is desirable. On the other hand, the importance of 
labor is greater, and the importance of the manager or entre- 
preneur is less, in agriculture than in manufactures ; and on 
this account the stimulus given to the individual laborer by the 
sense of proprietorship is a far more potent factor in agriculture 
than in other industries. Large factories controlled by one 
entrepreneur employing hundreds of dependent workmen have 
proved economically superior in the manufacturing industry, 
because of the possibility of supervising the labor, checking and 
measuring its efficiency automatically. In agriculture, how- 
ever, technical skill remains far more important relatively to 
those commercial or financial talents which distinguish the 
successful employer than in any other great division of pro- 
duction. 

This question is primarily one of private profit, which the in- 
dividual must decide for himself, but the legislator and the 
scientific student can assist the farmer by helping him to develop 
and use a system of sound farm accounting, and in keeping 
him awake to those changes in prices, wages, and transportation 
charges to which the farm organization must adjust itself. On 
the whole, however, the emphasis is wisely placed by the aver- 
age educator, at the present time, upon the possibilities and 
opportunities of more intensive farming. In the past, exten- 
sive farming has been, and justifiably so, the rule in this coun- 
tr}^, and the force of inertia is all directed that way. But the 
demands of the future will be in the opposite direction. As 
cities multiply and the market approaches the farm, intensive 
farming will be forced upon the people, and the readier we are 
to adapt ourselves to this change, the less will be the friction 
and loss. Moreover, the ability to earn a living by intensive 
farming makes it easier to acquire a farm ; and we are strongly 
of the opinion, as will appear hereafter, that widely diffused 
ownership is better than a general system of tenancy, even 
where land values are high. 

Finally, it may be noted that practically every European coun- 
try attempts by legislation to increase the number of small 



6o2 OUTLINES OF ECONOMICS 

holdings ; and in a mixed problem of this kind, which is as 
much psychological and social as strictly economic, the instincts 
of the majority are likely to have a sound social basis. Even 
in England, where comparatively large farming has had the 
greatest opportunity and the most favorable environment, the 
consensus of opinion seems to favor the encouragement of small 
holdings. English authorities maintain, as a rule, that a mixed 
system of large and small farms is the ideal condition, but that 
at present the emphasis should be placed on intensive farming. 
In 1889 a (British) select committee on the subject recom- 
mended unanimously that " the extension of a system of small 
holdings is a matter of national importance " ; and in 1892 Par- 
liament passed the Small Holdings Act which empowers county 
councils to purchase land and sell or lease it in small holdings. 
Purchasers were required to pay one fifth of the price on taking 
possession, and the remainder in fifty years. In the beginning 
the act does not appear to have been a glowing success, and by 
1903 only 62 small holdings, covering 248 acres, had been sold, 
and 166 buildings, covering 373 acres, let. In 1907, however, 
a new Small Holdings and Allotments Act was passed, special 
commissioners were authorized to ascertain the demand for 
small holdings in the various counties, and county councils 
were authorized to acquire land compulsorily. Between the 
passages of this act and the end of 19 12 various county councils 
acquired 155,000 acres of land, all of which, except two per cent, 
was leased to small holders. In 1912 there were 292,720 small 
holdings (one to fifty acres) in England and Wales, of which 
9937, or about 3 per cent, had been provided by county councils. 
While there is a marked difference of opinion in Great Britain 
on the subject, the weight of testimony and balance of opinion 
plainly incline towards the conclusions : (i) that an. extension of 
small holdings is desirable not only from the standpoint of 
national well-being but from that of the agricultural laborer as 
well ; (2) that agricultural laborers who employ farming methods 
suited to small holdings can make a decent living without an 
excessive amount of toil, in proof of which there seems to be a 
large unsatisfied demand for these small holdings ; (3) that small 



AGRICULTURAL PROBLEMS 603 

holdings under private land owners are likely to decline rather 
than increase in numbers, owing to insecurity of tenure and high 
rents ; (4) and that in consequence the intelligent assistance of 
the government is needed to achieve the desired results.^ 

We would not be misunderstood. A universal system of small 
holdings would be good for no country, as a certain number of 
large farmers, assisted by abundant capital, are needed to set 
the pace in the improvement of agricultural methods. And in 
the United States, it is hoped, small holdings on the British 
scale will not have to be considered for many generations. But 
this country as well as England needs to cultivate that spirit 
which has made Danish agriculture, in spite of great obstacles, 
such a marvelous success ; and it is imperative to avoid, if we 
can, the growth of those conditions which have drawn so much 
of the best blood of rural England to the cities. Both of these 
objects, we believe, will be measurably advanced by the encour- 
agement of intensive farming. 

Ownership and Tenancy. — The essential facts bearing upon 
the subject of farm ownership and tenure are summarized in 
Table II, printed on the following page. 

Section A of the table shows that share tenancy is increasing 
in the United States, and that the proportion of farms operated 
by their owners was smaller in 19 10 than in any earlier census 
year. Two interpretations of this phenomenon have been ad- 
vanced. According to the first, which is based partially upon 
the statistics cited in Section B of the table, the growth of 
tenancy is due primarily to the increasingly rapid rise of farm 
laborers from the position of wage earner to that of tenant. 
In this view, accordingly, the increase of tenancy is encourag- 
ing. According to the second interpretation, based partially 
upon the facts presented in Sections C and E, the growth of 
tenancy is not an encouraging sign, and indicates that it is 
becoming more and more difficult to acquire ownership of land 
in this country. The statistics of ownership under C prove 
that there is a steady movement from tenancy to ownership as 
farmers grow older. More than 70 per cent of the farmers 

* Cf. The Report of the Land Enquiry Committee, vol. i, Part ii, Chap. iii. 



6o4 



OUTLINES OF ECONOMICS 



TABLE II 

Statistics of Farm Ownership and Farm Tenure in the United 
States: 1880-19 io 



C { 



D{ 



Per cent of farms operated by owners . . 
Per cent of farms operated by cash tenants 
Per cent of farms operated by share tenants 

Per cent of males employed in agriculture : 

Who are owners 

Who are tenants 

Who are laborers and others .... 

Per cent of persons owning farm homes : 

All ages 

Under 25 years 

25 to 34 years 

35 to 44 years 

45 to 54 years 

55 years and over 



Per cent of owners of rentedfarms who own : 

1 farm 

2 farms 

3 and under 5 farms 

5 and under 10 farms 

10 and under 20 farms 

20 farms and over 



Per cent of farm homes owned : 

Free 

Encumbered 

Encumbered, all ages . . 
Encumbered, under 25 years 
Encumbered, 25 to 34 years 
Encumbered, 35 to 44 years 
Encumbered, 45 to 54 years 
Encumbered, 55 years and over 



1910 



63.0 
13.0 
24.0 



66.4 
33-6 



1900 



64.7 

I3-I 
22.2 



42.3 
23.1 
34-6 

64.4 
27.8 

45-3 
64.4 

70.7 
81.4 

80.0 

11.4 

5-4 

2-3 

0.7 
0.2 



69.0 
31.0 
31.0 
29-3 
35-5 
36.6 

31-8 
24.6 



1890 



71.6 

lO.O 

18.4 



42.0 
16.6 
41.4 



65-9 
32.6 
49.8. 
64.0 

72-3 
82.2 



71.8 
28.2 
28.2 
21.9 

31-9 
31.8 
30.2 
22.6 



The statistics opposite B are in the nature of estimates, a small number of 
female owners and tenants being included under "laborers and others." The aggre- 
gate percentages opposite A differ from those opposite C, owing to the fact that they 
were collected by different departments of the census, and apply to slightly different 
areas. The agricultural statistics published in the reports of the Thirteenth Census 
are not so detailed as those published in the reports of the Twelfth Census. 



AGRICULTURAL PROBLEMS 605 

between 45 and 54 years of age, but only 45.3 per cent of those 
between 25 and 34 years of age, owned the farms which they 
operated in 1900. This steady advance is encouraging; but 
the comparison of the figures for 1900 and 1890 indicates that 
the rate of advance is decHning. Moreover, the statistics pre- 
sented in Section E show that the proportion of owned farms 
which were burdened with indebtedness was, for every age group, 
larger in 1900 than in 1890, and, in the aggregate, larger in 1910 
than in 1890. 

The statistics presented in Table II and the two interpretations 
of their meaning are not, in reality, inconsistent. Tenancy is 
more frequent in the South Central and South Atlantic states 
than in other sections of the country, and more prevalent among 
colored farmers than any other class. Here, evidently, tenancy 
does represent an advance. The negroes who are tenants today 
were farm laborers a few years ago and slaves a half century 
back. On the other hand, tenancy is also prevalent and grow- 
ing in the richest farming district of the country, a district in 
which farm values are high and advancing very rapidly ; and 
in this district — the North Central states — there is evidence 
of a close though not perfect correlation between farm values 
and tenancy.^ 

There is no cause for grave alarm concerning farm tenancy in 
this country. Although the census of 1900 revealed one land- 
lord who owned 704 farms worth $4,545,230, Section D of Table 
II shows that 80 per cent of the landlords owned only i rented 
farm, and 96.8 per cent less than 5 rented farms ; while the 
additional fact that 78.8 per cent of the landlords lived in the 
same county in which their farms were located proves that 
absentee landlordism has not developed to any extent in this 
country. But we cannot regard present tendencies with all the 
complacency exhibited by some writers.^ For not only has it 
been shown that the increase of tenancy in the North Central 
states is probably due to the increasing difficulty of acquiring 

1 See H. C. Taylor, Agricultural Economics, pp. 224-250. 

' See Twelfth Census, Agriculture, Part I, pp. Ixxvii-lxxxi ; and E. L. Bogart in 
the Journal of Political Economy, vol. xvi, pp. 201— 211. 



6o6 OUTLINES OF ECONOMICS 

land consequent upon advancing land values ; but tenancy is 
almost certain to increase as land values advance, unless the 
American farmer learns how to get a living from smaller hold- 
ings. And land values are increasing with almost startling 
rapidity. In the four years 1911-1915 the value of improved 
farm land in this country increased over 25 per cent. When 
land goes to $200 an acre, the average young farmer can neither 
save enough nor command enough credit to buy a farm of 160 
acres and equip it properly. We shall have either more tenancy 
in the older sections of the country, as time passes, or smaller 
farms and a different type of agriculture. As stated above, the 
latter change would probably do more good than harm in the 
end. Our only fear is that the American farmer may not adjust 
himself to it rapidly enough. 

And it is doubtful whether we ought to derive comfort from an increase 
in the proportion of owners — as shown in Section B of Table II — when 
this increase results from an exodus of the agricultural population to the 
cities, which must itself be regarded with grave apprehension. Some 
writers explain away the increase of tenancy by dividing the agricultural 
class into three reservoirs, — owners, tenants, and others (presumably 
laborers) , — and assure us that the swelling volume of the middle reservoir 
is due to an increasingly rapid flow from the labor reservoir to the tenant 
reservoir, rather than a decreasingly rapid flow from the tenant reservoir to 
the reservoir of owners. But what about the flow from the labor reservoir 
to non-agricultural occupations? And how much of the diminution of 
ownership in trade and manufactures should be charged to the same move- 
ment of population from the country to the city? It is a condition, not a 
theory, confronting us, and when we start to explain this condition, it is 
not permissible to halt midway in the explanation. 

Farm Labor and Earnings. — It is not difficult to understand 
the " exodus from the farm " when we consider the demands 
which farming makes on the industry and managerial skill of the 
farmicr, the lure of city life, and the relatively small amount of 
cash which the farmer has at his command. The labor and 
drudgery of farm life are steadily being lightened, the income 
of the farmer has risen rapidly in late years, and as a recent 
writer tells us, " it is probably true that the farming population 
of the United States, consisting as it does of more than thirty 



AGRICULTURAL PROBLEMS 607 

million people, has a larger average income per family than any 
other equally homogeneous group of individuals of anything 
like the same size anywhere in the world." But when taxes 
and interest on indebtedness are paid the average farm family 
has little actual cash to spend on amusements, and a careful 
estimate made by the same writer for the year 1909 " shows 
that after all the expenses are paid the average family has $724 
of net earnings, of which $322 was earned by the capital in- 
vested in the farm, and $402 by the labor of the farmer and his 
family. These $724 of net earnings were received by the family 
in the following manner : $303 in cash, $35 as fuel, $125 as rent, 
and $261 as food furnished by the farm." ^ 

There can be no doubt, however, about the improvement in 
the conditions and wages of farm labor. The movement of 
farm wages since the Civil War is described statistically in 
Table III, following. From this it appears that farm wages 
were higher in the last year for which statistics are available 
than ever before, if we properly discount the inflated currency 
in which wages were paid in 1866, 1869, and 1875. Moreover, 
the testimony is practically unanimous to the effect that the 
increased use of farm machinery has not only reduced the hours 
of labor, but has diversified and lightened the toil of the farm 
hand. Added to these evidences of increasing material comfort 
is the reassuring fact that the farm hand retains, in a large 
degree, his superior social position. The native white farm 
laborer usually eats at the same table with his employer, shares 
his social diversions, and in general mixes in the same social 
class on terms of approximate equality. 

There is room, however, for much improvement. The hours 
of labor are long in the country, — 10 in winter, 12 in summer, 
13 in harvest season, according to our latest information, — 
and, except on a very small number of farms, there are two or 
three months in the year when the laborer cannot secure full 
work. " The able-bodied, industrious man desirous of employ- 
ing his full vigor continuously finds a limitation in the average 

1 E. A. Goldenweiser, "The Farmer's Income," The American Economic Review, 
vol. vi, pp. 46, 48. 



6o8 



OUTLINES OF ECONOMICS 



TABLE III 

Wages of Farm Labor in the United States for Specified Years : ^ 

1866-1915 

(Wages expressed in paper currency for the years 1866, 1869, 1875) 



Year 


Per Month 


Per Day 
AT Harvest 


Per Day Other 

Than Harvest 


Without 
board 


With board 


Without 
board 


With board 


Without 
board 


With board 


191S 


$30.15 


$21.26 


$1.92 


$1.56 


$1.47 


$1.13 


1914 


29.88 


21.05 


1.91 


1-55 


1-45 


I-I3 


1911 


28.77 


20.18 


1-85 


1.49 


1.42 


1.09 


1910 


27.50 


19.21 


1.82 


1-45 


1.38 


1.06 


1902 


22.14 


16.40 


1-53 


1-34 


I-I3 


.89 


1899 


20.23 


14.07 


^■2,7 


1. 12 


1. 01 


■ -77 


1898 


19.38 


1343 


1.30 


1.05 


.96 


.72 


189s 


17.69 


12.02 


1. 14 


.92 


.81 


.62 


1894 


17-74 


12.16 


1-13 


-93 


.81 


-63 


1893 


19.10 


13.29 


1.24 


1.03 


.89 


-69 


1892 


18.60 


12.54 


1.30 


1.02 


.92 


•67 


1890 


18.33 


12.45 


1.30 


1.02 


.92 


.68 


18S8 


18.24 


12.36 


1-31 


1.02 


.92 


.67 


188s 


17.97 


12.34 


1.40 


1. 10 


.91 


-67 


1882 


18.94 


12.41 


1.48 


1-15 


-93 


■67 


1879 


16.42 


10.43 


1.30 


1. 00 


.81 


•59 


187s 


19.87 


12.72 


1.70 


1-35 


1.08 


.78 


1869 


25.92 


16.5s 


2.20 


1-74 


1.41 


1.02 


1866 


26.87 


17-45 


2.20 


1-74 


1-49 


1.08 



condition of farming. Seed time and harvest make busy their 
respective periods, but whenever the frost of winter or the 
drought of summer suspend the activity of vegetation, there 
will be an interval in the work of the cultivator." ^ 

'^See Crop Reporter, vol. xiv, No. 3, and Monthly Crop Report, vol. ii, No. 3. 
Broad averages are particularly unsatisfactory in dealing with the wages of farm 
labor, and the reader should regard this table not as an exact exhibit of money 
wages, but as a compendious method of describing a movement the details of which 
are beyond the scope of this treatise. For more adequate discussions, see Bulletin, 
No. 26, Miscellaneous Series, and Bureau of Statistics, Bulletin 99, U. S. Depart- 
ment of Agriculture. 

^ J. H. Blodgett, " Wages of Farm Labor in the United States," p. 25. Bulletin, 
No. 26, Miscellaneous Series, U. S. Department of Agriculture, p. 25. 



AGRICULTURAL PROBLEMS 609 

Furthermore, the best evidence obtainable supports the con- 
clusion that while " skilled labor, owing to its contact with ma- 
chinery and the influence of education, has attained increased 
efficiency," " unskilled and irregular labor has lost much of its 
former adaptability and value to the farm." ^ Worst of all, 
there is rapidly developing a class of migratory or casual agri- 
cultural laborers who drift from city to country and back again, 
who have no ambition to establish themselves permanently 
upon the land, and yet teach the farmer to rely upon their 
assistance, and debase the real standard of living of the laborer 
who adopts farming as a serious occupation, and looks forward 
to the acquisition some day of a farm of his own. 

Farm Indebtedness and Agricultural Credit. — The favorite 
instrument by which land ownership is achieved in this coun- 
try is the farm mortgage. As shown above, 33.6 per cent of the 
farms in this country were mortgaged in 1910, and this propor- 
tion had increased from 28.2 per cent in 1890. But this is not 
in itself alarming. The ratio of mortgage debt to farm value 
was only 27.3 per cent in 1910 as against 35.5 per cent in 1890, 
and the owner's average unencumbered equity per farm in- 
creased from $2200 in 1890 to $4574 in 1910. Moreover, the 
proportion of mortgaged farms in the latter year was higher 
in Iowa and Wisconsin than in any other states, although agri- 
culture is particularly flourishing in these states. Statistics 
collected in 1890 indicate that nearly 65 per cent of mortgage 
indebtedness of farms is contracted for the purpose of buying 
the farms, from 1 5 to 20 per cent for stocking, equipping, drain- 
ing, and improving farms, while probably not more than 5 or 6 
per cent represents losses, household expenses, and " unproduc- 
tive consumption." The farm mortgage accordingly is not 
necessarily a bad thing. It is "a mere business venture " and 
in this country has proved a successful venture in a surprisingly 
large proportion of cases. 

If farms are operated more efficiently by their owners than 
by tenants or hired managers, it is obviously desirable to get the 
title to the farm into the hands of the farm operator as soon as 

^ Final Report of the Industrial Commission, p. 92. 
2R 



6lO OUTLINES OF ECONOMICS 

possible. For this purpose some use of credit is usually neces- 
sary. Credit also must usually be used to secure the proper 
amount of farm machinery, stock, and other equipment. Agri- 
culture today has become a highly capitalized industry, employ- 
ing in this country, it is estimated, about twice as much capital 
as the manufacturing or factory industries. And the indications 
are that the average farmer at present cannot secure, or at least 
does not employ, enough circulating capital. Studies have been 
made of the earnings of farmers classified according to the amount 
of capital employed on each farm ; and these indicate that, after 
due deduction for interest upon all capital employed, the re- 
maining net income varies directly with the amount of capital 
employed, until the latter reaches $25,000 or $30,000. The 
New York studies indicate that farmers working with less than 
$5000 capital earn less than the ordinary farm hand in the same 
vicinity ; and that in the districts covered, the average farmer 
cannot earn a fair return for his labor unless he has the use of 
from $10,000 to $20,000 worth of capital. The figures in ques- 
tion are possibly affected by the probable fact that it is the 
better class of farmers who are enabled to obtain the larger 
amount of loan capital. But v/hether this be the fact or not, 
it is obviously desirable that the farmer should be able to secure 
whatever amount of capital is necessary, at the lowest practi- 
cable cost. 

At the present time credit facilities are not adequate in many 
rural districts. Recent statistics collected by the federal De- 
partment of Agriculture, for instance, show that the average 
rate for interest and commissions on farm mortgage loans ex- 
ceeds 7 per cent in twenty-five states, and rises as high as 10 
per cent in New Mexico, Montana, and Wyoming. This is the 
average rate, and there are presumably many instances of very 
much higher rates. The average commission which it is neces- 
sary to pay to the middleman or intermediary exceeds 2 per 
cent a year in certain districts of North Dakota, Oklahoma, 
and North Carolina. The average rate for interest and other 
costs on loans to farmers on personal security exceeds 10 per 
cent in twenty states and rises to 15.6 per cent in Oklahoma, 



AGRICULTURAL PROBLEMS 6il 

13.8 per cent in New Mexico, and to 12.4 per cent in Alabama. 
The average rate exceeds 12 per cent on 57.3 per cent of the 
loans reported in North Dakota, on 55.3 per cent in New Mex- 
ico, 25.5 per cent in Alabama, and 34.7 per cent in Colorado. 
Even in the state of Michigan 5 per cent of the loans on 
personal security cost the borrower more than 12 per cent a 
year. Recent investigations made by the Comptroller of the 
Currency also make it plain that in some sections of the coun- 
try extortionate rates of interest are being charged by banks 
on farm loans ; and that in some districts the farmers are really 
being exploited by rural " loan sharks." 

American farmers not only pay an unnecessarily high price 
for the credit which they receive, but it is not supplied in the 
most convenient and suitable forms. The farmer who borrows 
to buy a farm or to construct a barn wants a loan for more than 
four or five years in order to avoid the trouble of expense and 
renewal, with the periodic danger of foreclosure. The loan 
should run in many cases for twenty-five years or more ; the 
payment should be arranged so that the principal may be 
gradually extinguished as the interest is paid, and the farmer 
should retain the right to extinguish the entire principal when- 
ever it became convenient or practicable for him to do so. In 
the case of short-time loans on personal security, similarly, the 
farmer does not want a sixty-day or ninety-day loan, the kind 
of accommodation which commercial banks prefer to give, but 
needs usually a loan running from six months to a year, in 
order to cover the waiting period between planting and harvest 
time. Moreover, the banks in some sections of the country at 
present force farmers who borrow from them to specialize in 
one crop — a money crop — in order to keep the security in 
some easily realizable form. American banks have in this way 
helped to prevent the adoption of diversified farming. 

In Europe, agricultural credit is furnished at low cost and con- 
venient terms by a series of mortgage land banks and farmers' 
loan societies or credit unions, which vary greatly in detail and 
structure but rest upon certain common fundamental principles. 
Long-time credit is provided by mortgage land banks, the oldest 



6l2 OUTLINES OF ECONOMICS 

form of which is perhaps the Prussian Landschaft. These 
banks lend to their members on real estate mortgage, and then 
issue bonds secured by the entire body of mortgages in such a 
way as to replace or reenforce each individual's credit with the 
credit or security of the whole group. In some of these associa- 
tions all the property of the members is pledged for the support 
of the bonds, but experience makes it plain that this is unneces- 
sary and that the mortgages themselves, under proper manage- 
ment, afford sufficient security to insure ready sale for the bonds. 
The associations or banks which provide short-time credit differ 
greatly in form. Some are stock companies, receive savings de- 
posits, and obtain a considerable part of the money funds which 
they lend from stock subscriptions and deposits. In others a 
group of men simply pool their credit, borrow from outside 
sources on their unlimited liability, and lend the proceeds of 
these loans to the members of the union. Machinery, organi- 
zation, and rules differ, but the fundamental principles and re- 
quirements are as follows : 

1. A pooling of credit and securities so that the debt of 
each member is backed by the collective credit or good-wUl of 
the association. 

2. Rigid scrutiny of the loan and the security by appraisers 
(usually neighbors of the borrower) who have every opportunity 
of knowing the circumstances of the borrower and the value of 
the security offered. 

3. Limitation of credit to loans for productive purposes. 
Th^ grant of credit for speculative purposes is strictly forbidden, 
and many societies provide that loans may be called if the 
money is not properly used. 

4. Management in behalf of the borrower. This represents 
the most essential difference between the cooperative credit 
associations of Europe and the credit institutions of this coun- 
try. Where stock is issued, each stockholder usually has only 
one vote, and dividends are limited, usually to the rate paid 
upon borrowed money. Additional earnings, if any, are turned 
into a surplus fund which, if the union is dissolved, goes to charity 
or some public purpose. 



AGRICULTURAL PROBLEMS 613 

5. Adaptation of the period and terms of the loan to the 
needs of the creditor, with provision for amortization and per- 
mission to pay ofi the loan whenever the debtor finds it possible. 

Cooperative credit associations or rural banks have multi- 
plied rapidly all over Europe. They have greatly reduced 
rates of interest to farmers, and do an enormous, amount of 
business at low cost and with very little loss. Large central or 
district associations have been established which bring the rural 
societies in touch with city money markets, help to procure 
funds for the local associations, and guide their activities by 
constant inspection and audit. As a natural corollary, co- 
operative supply associations have been developed in many 
places, which furnish fertilizers, farm machinery, seed, and other 
supplies to members at the lowest possible prices. In New 
Zealand and Australia the State itself has, apparently with 
entire success, undertaken the function of lending money to 
farmers for the improvement and development of agricultural 
land. In this country a few states have adopted laws facili- 
tating the formation of rural credit associations, and in July, 
191 6, the President approved an act of Congress the purpose 
of which is well indicated by its longer title : " An act 
to provide capital for agricultural development, to create 
standard forms of investment based upon farm mortgage, to 
equalize rates of interest upon farm loans, to furnish a mar- 
ket for United States bonds, to create government depositaries 
and financial agents for the United States, and for other 
purposes." 

This law represents an earnest attempt to give expression to 
the principles set forth on the preceding page. The machinery is 
perhaps necessarily, but unfortunately, cumbersome. The law 
creates a hierarchy of land banks, the control of which is cen- 
tralized in a Federal Farm Loan Board composed of the Secre- 
tary, of the Treasury and four members appointed by the Presi- 
dent, to serve for terms of eight years. This board is to be 
assisted by farm loan registrars to supervise the issues of farm 
loan bonds and to have custody of the mortgages and securities 
upon which they are based ; by land bank appraisers to deter- 



6l4 OUTLINES OF ECONOMICS 

mine the value of properties offered as securities ; by " as 
many land bank examiners as it shall deem necessary " ; and 
by such attorneys, experts, and other employees as are required 
to conduct the business of the board. The country is to be 
divided into twelve districts, in each of which there shall be a 
Federal Land Bank with capital stock of not less than $750,000. 
The government is to supply this capital unless it is forthcoming 
from other sources, thus involving the government in a maximum 
stock subscription of $9,000,000. Government shares are to 
draw no dividends. It is obviously intended and hoped that 
these land banks shall operate through 'small National Farm 
Loan Associations composed of persons desiring to borrow 
money under the act ; but in case such loan associations are not 
created rapidly or widely enough, provision is also made for 
joint-stock land banks, with a capital of not less than $250,000, 
only half of which need be paid in cash before operations are 
begun. The larger federal land banks are also authorized to 
create branches and if necessary to lend money through agents 
scattered throughout the country. 

No provision is made for loans on personal property or per- 
sonal security. Loans must be secured by first mortgages not 
exceeding in amount 50 per cent of the .value of the land 
and 20 per cent of the value of the improvements thereon 
pledged as security. Interest rates are limited to 6 per cent ; 
proper provision is made for the amortization of the principal 
while the interest is being paid ; the loan may run from five to 
forty years and may be issued only to a person who is ''at the 
time, or shortly to become, engaged in the cultivation of the 
farm mortgaged." Such loans may be made only for the pur- 
pose of purchasing land for agricultural uses ; to provide for 
the purchase of equipment, fertilizers, and live stock ; to pro- 
vide for buildings and the improvement of farm lands ; or to 
liquidate the indebtedness of the owner of the land mortgaged. 

The greatest danger of such legislation, perhaps, is that the 
extension and multiplication of credit will increase the demand 
for land, raise its price, and so injure the very classes which it 
is designed to aid, namely, young farmers and tenants who are 



AGRICULTURAL PROBLEMS 615 

working hard to acquire title to the farms which they operate. 
Moreover, there is an important connection between the interest 
rate and the price of land which must be considered in this 
connection. Land value is frequently expressed as ''so many 
years' purchase," i.e. so many times the annual rent or net yield, 
the number of years' purchase depending upon the interest rate. 
Roughly speaking, " twenty-five years' purchase " corresponds to 
a four per cent interest rate, " twenty years' purchase " to a 
five per cent interest rate. If we reduce the interest rate, will 
we not automatically increase the price of land ? 

While there is a real connection between land values and the 
interest rate, it does not follow that a reduction of, say one fifth, 
in the interest rate wiU be followed by an increase of one fifth 
in the value of land. The interest rate which largely controls 
in this connection is the rate on purchase-money mortgages, 
which do not include so large an allowance to cover risk and 
similar costs as do the other and smaller farm loans, interest 
on which it is the primary purpose of this legislation to reduce. 
In consequence, while it is probable that improved credit will 
tend to raise the price of land, it is almost certain that the in- 
crease will not be commensurate with the relief to the farmer 
afforded by the reduced cost of loans. 

Tenancy versus Encumbered Ownership. — At this point it 
is necessary to discuss briefly the question when and where — 
if ever — tenancy is to be preferred to land ownership. For 
though it may come as a surprise to some American readers, 
many foreign authorities of the highest rank strongly advocate 
tenancy in preference to ownership when land has become very 
valuable. In the expert evidence given before the British com- 
mittee of 1906 on small holdings, for instance, the balance of 
opinion seems to have inclined toward tenancy rather than 
ownership. 

Here again we meet one of those mixed economic and psycho- 
logical questions to which no simple answer can be given. In a 
frontier or newly settled community, there is, of course, little 
reason for tenancy from any standpoint. But in an old com- 
munity, where land values are high and are as likely to fluctuate 



6l6 OUTLINES OF ECONOMICS 

downwards as upwards in the next score of years or so, the eco- 
nomic arguments in favor of tenancy are exceedingly strong if 
not altogether convincing, (i) Under such circumstances the 
farmer who insists upon holding the title to the land which he 
tills must either go deeply into debt, or understock his farm, or 
both. To underequip the farm means poor agriculture ; and 
a heavy debt hangs like a millstone around the neck of a farmer 
when land values are not on the increase. The tenant farmers 
of England have had a far more pleasant time since 1873 than 
the small landowning farmers whose holdings were encumbered 
with debt at that time. (2) The ownership of land throws upon 
the farmer all the responsibilities of the speculative entrepreneur, 
and other things being equal — if they can ever he regarded as 
equal — it is desirable for the man of small means to avoid 
these responsibilities. The tenant system offers a means of 
insurance against some of these risks. (3) Such insurance be- 
comes all the more advantageous and encumbered ownership 
all the more disadvantageous because of the well-known fact 
that land yields a net return, year by year, lower than almost 
any other form of property. Part of this is due to the social 
prestige of landownership and part to the fact that over very 
long periods the small annual profit on land is likely to be com- 
pensated for by an increase in the selling value of the land. 
Under such circumstances landownership is partly a luxury and 
partly a method of saving, usually for the descendants and heirs 
of the saver. Both factors conspire to make land a poor invest- 
ment for the man of small means. He cannot afford luxuries, 
on the one hand, and he must find a business calling, on the 
other hand, that yields him a quick return. (4) And finally, it 
must be noted that the question of tenancy is not like the labor 
problem which has developed in the factory industries. The 
tenant is not a wage earner. He may be as independent as the 
manufacturer who hires the land, buildings, and possibly the 
machinery with which he works. The problem of tenancy, 
therefore, has no necessary relationship to the problem created 
by the existence of a class of permanent wage earners. The 
small entrepreneur still holds the field in agriculture, all over 



AGRICULTURAL PROBLEMS 617 

the world. The question is simply whether he shall hire his 
plant or own it. 

Notwithstanding the fact that tenant farming may go hand in 
hand, as it does in England, with good farming, and notwith- 
standing the desirability of reducing the speculative risks of an 
industry which is at best much too uncertain, the problem can 
never be settled on economic grounds alone ; and if we add to 
the economic virtues of ownership its social and moral advan- 
tages, the final verdict must be rendered against tenancy. 
Ownership not only spurs the zeal of the farmer, dignifies his 
occupation, and inculcates a love of the soil which nothing else 
inspires in so great a degree, but it gives the farmer a stake in 
the political game, steadies him, and thus improves his citizen- 
ship. It is perfectly plain that ownership cannot be enforced 
upon a people that are not prepared for it. And it is equally 
obvious that the virtues which go with ownership may and often 
do degenerate into vices : the peasant proprietor's love of the 
soil occasionally becomes land worship, his thrift avarice, his 
conservatism blind fear, and his industry cruel, — he drives 
himself and wife and children at a pace that would put the 
sweater to shame. 

But we are not advocating the extension of landowner ship 
through state aid. We simply call attention to the desirability 
of fostering those qualities which lead to the diffusion of owner- 
ship and are in turn strengthened by ownership ; and we main- 
tain that the American people at present are in no danger of 
excessive thrift or of the sordid materialism of peasant proprie- 
torship at its worst. The tendencies and the dangers are almost 
all in the opposite direction. If, in the next fifty years, the 
farmers of the Middle West become predominantly tenants, it 
will not be because tenancy is economically and socially superior 
to ownership, but because the farmers of that district have not 
had the thrift to save and the ability to adapt themselves to 
more intensive agriculture. And the step will be backward, not 
forward. The popular instinct which in this country causes an 
increase of tenancy to be regarded with distrust is a sound 
instinct. 



6l8 OUTLINES OF ECONOMICS 

A minor disadvantage of tenancy is found in the fact that tenancy, when 
it becomes predominant, raises difficulties that can only be met by constant 
State interference. Short leases, with no indemnification to the tenant for 
the improvements which he has made, lead to rack-renting, exhaustion of 
the soil, and class hatred between landlords and tenants. Long leases, on 
the other hand, aiiord insufficient protection to the landlord ; because when 
prices are high the tenant thrives and pays his rent promptly, but when 
prices fall rents go unpaid and the landlord has no real redress. In Eng- 
land the situation has been met by a system of short-time leases together 
with compensation to the tenant — a legal obligation which the landlord 
cannot escape by "contracting out" — for any improvement made by the 
tenant whose value he has not exhausted. Neither party can abrogate a 
lease without a year's notice, although by mutual consent this maV be re- 
duced to six months. This system permits rentals to be adjusted frequently 
as prices change, rules out excessive competition, protects the landlord, and 
warrants the tenant in making any improvement required by good farming, 
since he knows that, if the landlord orders him out, he can collect on his de- 
parture the actual value of improvements made by him, whose benefits he 
has not had time to reap. In practice, the incoming tenant usually pays for 
the unexhausted improvements, and disputes are settled by arbitration. 
Under this system, " the relation between landlord and tenant is very satis- 
factorily arranged, the farmers are, as a rule, contented with the present 
system, and the fields of England prove that landownership on the part of 
farmers is not essential to good agriculture." ^ 

Marketing of Farm Products. — The work of the farmer is 
not finished until he has successfully sold his produce. Com- 
paring the price received by the farmer with the retail price of 
the same produce, many critics have complained that the inter- 
mediate distributive ^ process is wasteful and expensive. But 
careful investigation of the necessary costs of marketing does 
not indicate, on the whole, that our distributive system is so 
inefficient as to call for complete replacement. Improvement of 
present methods, and not revolution, seems to be the proper 
solution. 

On the other hand, the marketing system is manifestly defec- 
tive at many points. The farmer himself is responsible for some 
of the most costly defects. He frequently does not show suffi- 
cient care in producing the exact varieties of products most in 

1 H. C. Taylor, The Decline of Landowning Farmers in England, p. 6i. 
^ The word "distributive" is used in the popular sense in this chapter. 



AGRICULTURAL PROBLEMS 619 

demand, or in sorting and crating them for market after they 
have been produced. Goods are carelessly and dishonestly 
packed ; there is sometimes a dearth of buyers and sometimes 
a monopolistic agreement among buyers at country points. 

There is also room for improvement in the transport of such 
goods from the country buying point to the wholesale markets. 
Many railroads do not have a sufficient supply of refrigerator 
cars and lack facilities for handling perishable goods. A suffi- 
cient number of cars is frequently not provided just when they 
are most needed, there are many avoidable delays in transit, and 
frequently great difficulties in adjusting and paying claims for 
damages. Generally speaking also, railway tariffs favor through 
traffic at the expense of local traffic and aire thus partly respon- 
sible for the concentration of manufactures and population in the 
large cities, preventing that diffusion of people throughout the 
country which would furnish a large number of small local 
markets. 

Among the wholesale dealers, particularly the commission 
houses, there is also room for improvement. Fraud and sharp 
practices have been common in the past. Well-organized and 
convenient markets have not been provided, there has not been 
enough inspection or publicity, and where the goods are dis- 
posed of at auction collusive agreements have frequently existed 
betv/een particular traders and the auction company itself. 

There is no simple or general rem^edy for these conditions. 
In order to secure good country markets, cooperation among 
farmers has proved successful and probably offers the logical 
and best way of disposing of farm products at country points. 
Cooperation has also been used successfully in the market- 
ing of perishable goods, and here the commission system has 
been partly replaced by associations of farmers or growers such 
as the California Fruit Growers and Shippers Association, which 
maintains auction rooms in eastern cities and sells its own 
products directly. The Southern California Fruit Exchange in a 
few years reduced the cost of marketing California fruits from 
10 per cent to 3 per cent of the selling value. 

The cooperative marketing association and the intermediate 



620 OUTLINES OF ECONOMICS 

trader who buys from the grower and sells to the retailer have 
in common two points of superiority over the commission sys- 
tem. They replace the lukewarm interest of an agent by the 
care and solicitude of an owner, and by shipping in large quan- 
tities they are in position to obtain much better rates from the 
railways, to say nothing of the other economies effected by 
handling goods on a large scale. The cooperative marketing 
associations have also effected great economies by carefully 
studying prices in the various markets and distributing their con- 
signments so as to get the highest prices prevailing at the time. 
The independent trader, however, can select the most avail- 
able market even more successfully than the cooperative asso- 
ciation, and speaking generally we do not expect to see the 
commission house displaced by a cooperative machinery which 
transfers products direct from the farmer to the retailer. An 
intermediate mechanism is probably necessary. It is a logical 
and probably an economical manifestation of the division of 
labor. The actual purchaser or trader, however, will probably 
slowly displace the commission man ; and there can be little 
doubt that the farmer has gained enormously by the substitu- 
tion of the trader for the commission house in the marketing 
of the great staple products. The trader comes almost to the 
door of the farmer with constant bids for his grain. He is an 
expert in railway rates, is in constant telegraphic communica- 
tion with the great markets of the world, and handles products 
in such large quantities as to reduce intermediate expenses to a 
minimum. Occasionally, as has sometimes been the case with 
the great line-elevator companies, he works in conjunction or in 
collusion with the railways, overbidding the small grain dealer, 
and forcing the railways to grant rebates on the large shipments 
which he commands. Even in this case, the farmer gains by the 
size and efficiency of the middleman (though the small dealer 
may suffer) because part of the economies effected — even those 
effected by discriminative railway rates — will come to him in 
the long run. Cases of monopolistic oppression are theoretically 
possible when there is only one buyer and one railway who are 
in collusion, and the farmer is deprived — because of high rail- 



AGRICULTURAL PROBLEMS 62 1 

way rates — from shipping his products elsewhere. But the 
loss to the farmer through extortion of this kind has in general 
been much more than counterbalanced by the striking economies 
effected by the great trading companies ; though this, of course, 
affords no justification either for monopoly or railway dis- 
crimination. Both should be suppressed, but in such a way as 
to save for the farmer the distributive economies effected by 
large-scale handling. 

Finally, the government can be of great assistance, provided 
the laws under which it works are passed after careful investi- 
gation and designed to improve rather than revolutionize exist- 
ing marketing machinery. Laws have been passed governing 
the grain trade, cold-storage warehouses, future trading in 
cotton, and the size and character of standard packages. More 
important still are the state laws providing for the regulation of 
commission merchants and the creation of marketing com- 
missions. 

Space does not permit a discussion of the laws regulating com- 
mission merchants passed by Minnesota (1899), New York 
(1913), and other states. Speaking generally, commission dealers 
under these laws must obtain a license from some state com- 
mission or official and post a bond for the benefit of consignors 
conditioned upon faithful observance of the law. The laws 
usually require licensees to keep an exact record of the circum- 
stances of each sale and to make returns to shippers within a 
very short period after each sale. Either by the statute itself 
or by administrative ruling it is quite common to prohibit the 
commission dealer from buying consigned products for himself 
or from selling them to any other corporation or firm in which 
he has an interest. Licenses may be revoked for malpractice 
of the following kinds : making false charges for cartage, 
handling, insurance, or other services not actually rendered ; 
failure to make prompt settlements with consignors ; rendering 
false statements as to the sale or condition of the goods on 
receipt ; sending out false information concerning prices or 
other market conditions ; maintaining combinations to fix 
prices ; violating or neglecting other features of the law. Not 



622 OUTLINES OF ECONOMICS 

a great many complaints have been registered under the Minne- 
sota law, " due partly perhaps to ignorance of the law's exist- 
ence, and partly to a feeling that it is hardly worth while to 
proceed under it. It may also be an indication that there has 
not been so much dissatisfaction among shippers as most people 
imagine." ^ According to most competent observers these 
laws have exercised on the whole a salutary effect and promise 
greatly to improve what has hitherto been one of the weakest 
links in the distributive chain, the ineffective commission mer- 
chant. 

In a number of states commissions or departments have been 
organized for the purpose of improving marketing methods. 
For the most part these commissions have not accomplished 
any very concrete results up to the present time. What is inost 
needed now is study and investigation rather than an attempt 
to introduce on a magnificent scale costly cooperative or other 
schemes whose practical efficiency has not been demonstrated 
either by practice or the most thorough advance study. Much 
more helpful and promising is the federal Office of Markets and 
Rural Organization, which by its careful investigations is 
gradually laying the basis for a scientific correction of the real 
defects and abuses which exist. 

Speculation. — The modern marketing or distributive mecha- 
nism not only relieves the producer of a large part of the specula- 
tive risk which attends the transmission of raw material from 
the farm to the consumer, and calls public attention to this specu- 
lative element by collecting or concentrating it, but it is respon- 
sible also for a large amount of unnecessary speculation which 
many persons believe to be particularly injurious to the farmer. 
We are not here concerned with the general evils of speculation 
but with the prevalent belief that speculative dealing in futures 
tends to reduce prices. " What is generally urged is that the 
professional short seller, by his sales of fictitious wheat or cotton, 
creates a fictitious oversupply in the market, which is just as 
instrumental in depressing prices as would be an abnormally 

' L. D. H. Weld, The Marketing of Farm Products, p. 453- The discussion at 
this point is largely based upon Professor Weld's admirable book. 



' AGRICULTURAL PROBLEMS 623 

large supply of actual wheat thrown on the market by the 
farmer." ^ This charge is frequently supplemented by the 
assertion that it requires less money in margins to " sell short " 
— or gamble on a fall in prices — than to " sell long " in antic- 
ipation of a rise, and that, in consequence, the weight of the 
speculative dealing in farm products is exerted in the direction 
of lower prices. 

This particular charge against speculation is confirmed neither 
by a priori reasoning nor by inductive analysis. Every " ficti- 
tious " sale of wheat, to use that as an illustration, must be 
balanced by an equivalent " fictitious " purchase. The " bear " 
who sells October wheat in July, even though he may hope to 
depress the price of October " futures," exercises no harmful in- 
fluence upon the actual July or " spot " price, which is con- 
trolled by the demand for and supply of actual wheat; and 
when October comes, " the short seller of July appears now as a 
buyer in order to cover his contracts, and if his trading has any 
effect on the market at all, it is to increase the demand, not the 
supply." 

It is very plain that the fictitious market may be artificially 
influenced by speculative deals, but as a general thing the ficti- 
tious market is ruled by the actual market, not vice versa; and 
the only influence exerted by gambling in futures upon " spot " 
prices (with which alone the farmer is concerned) is a good in- 
fluence. This influence arises out of the effect of future trans- 
actions in lessening price fluctuations and in modifying present 
use by anticipating future necessity. And the complaint that it 
requires less capital to " bear " the market than to " bull " it, 
as well as a great number of ingenious criticisms of a similar 
kind, would all be negatived — if they were true — by the in- 
evitable consequence that any permanent factor of this kind 
would he quickly appreciated by speculators and fully dtscounted. 
In no market are influences of this kind more accurately detected 
or more quickly dissipated by competitive forces than on the 
produce and cotton exchanges. 

1 N. I. Stone in the Report of the Industrial Commission, vol. vi, p. 189 ff., from 
which other quotations cited in this section are also taken. 



624 OUTLINES OF ECONOMICS 

Actual investigations of prices confirm the theoretical argu- 
ment made above. The average prices of spot wheat in Sep- 
tember, October, and November — just after harvest, when the 
ordinary farmer is compelled to sell — have been nearer the 
average price for the entire year, since the speculative wheat 
market has become highly organized, than in the forties and fifties 
when wheat was sold like any other farm product. And there 
are reasons for the belief that speculation has not only equalized 
yearly fluctuations, but that the leveling has been up, not down, 
in the interest of the farmer who is compelled to sell after 
harvest, as opposed to the wealthier miller or trader who in the 
past carried over a supply for the lean months. " It is not un- 
commonly stated that in the last few years futures in the wheat 
market have not, in the long run, stood enough above ' spots ' 
to cover all the expenses of carrying. Some suggested reasons 
for this are : cut charges for storage ; the failure of outside 
speculation to maintain the market against hedging sales ; the 
fact that the great elevators will buy wheat and carry it for 
what they can get, and perform the functions of both carrier 
and trader for the commission of one. In any case, the tendency 
is to bring all prices together." ^ 

Not only does " speculation " tend to equalize price fluctua- 
tions between dift'erent points of time and between different 
markets, but it serves the exceedingly useful purpose of provid- 
ing a " body of professional risk takers " whose function is to 
protect the actual merchandiser from many of the speculative 
risks inherent in modern business. This protection against 
risk is secured for the most part through " hedging," which 
has been defined " as a purchase or sale for future delivery in- 
tended to offset and thereby to protect an actual transaction 
in merchandise." The terminal grain elevator which has accu- 
mulated a large amount of grain sells a corresponding amount 
for future delivery and thereby eliminates nearly all of the specu- 
lative risks involved in its business. The miller who has taken 
a contract to deliver flour at some time in the future hedges by 

1 H. C. Emery, Speculation on the Stock and Produce Exchanges of the United 
States, p. 131. 



AGRICULTURAL PROBLEMS 625 

buying future wheat sufficient to produce the flour called for in 
his contract. The country grain buyer who knows that an inter- 
val of time must elapse between the purchase of grain and its 
sale at the point of destination finds similar protection in a 
" future " which permits him to specialize in the distributive 
function of getting grain from the producer to the ultimate con- 
sumer with a minimum of speculative danger. There are simi- 
lar operations in the cotton market. 

Speculation in the narrow sense, and even more truly the 
highly-organized market which we associate it with, are respon- 
sible for a certain amount of harmful gambling which should be 
suppressed; but in their ultimate economic effects they are 
highly useful institutions designed to concentrate the uncer- 
tainties and risks inherent in the very nature of production for a 
future market. And it is important to note that hedging, the 
transaction by which risks are eliminated for those who prefer 
to specialize in the less dangerous types of profit-seeking, would 
be impossible without the more speculative traders who prac- 
tically bet on future fluctuations of prices. To steady and 
reduce these fluctuations, provide a certain market, and elimi- 
nate the exploitation of the ignorant by the expert traders, 
speculation and the market mechanism which it requires seem 
to be necessary and inevitable. 

QUESTIONS 

1. Make a list of the economic factors which regulate the size of farms. 
Is the average farm likely to grow larger or smaller with the passage of time ? 
Is the narrow economic conclusion concerning the size of the farm, based 
upon maximum net profit to the individual farmer, subject to modification 
by reason of social or moral considerations? 

2. Has the net effect of the rural exodus been favorable or unfavorable 
to agriculture and the agricultural classes? to society generally? 

3. Does the increase of tenancy in the Southern states represent progress 
or retrogression? in the North Central states? 

4. Under what conditions is the cash rental superior to share tenancy? 
Would the "corn rent" — a sHding rental varying with the price of farm 
products — be superior to both ? Are short leases better than long leases 
for the landlord? 

5. Do the farmers in your locality suffer from the lack of credit facilities? 

2S 



626 OUTLINES OF ECONOMICS 

Have they any difficulty in finding safe and convenient investments for their 
savings ? 

6. What is the advantage of speciaHzed farming over diversified farming ? 
Do we imply, when we advocate diversified farming, that the farmer should 
"buy nothing that he can raise or make for himself"? 

7. Is speculation a "necessary" or an "unnecessary evil"? Is it an 
evil? 

REFERENCES 

Brace, H. H. The Value of Organized Speculation. 

Commissioner of Corporations. Report on Cotton Exchanges, Part v. 

BuTTERFiELD, K. L. Chapters in Rural Progress. 

Carver, T. N. Principles of Rural Economics. 

Eleventh Census. Real Estate Mortgages ; Farms and Homes; Proprietor- 
ship and Indebtedness. 

Twelfth Census. Vol. v, Agriculttire; Supplementary Analysis, "The 
Negro Farmer," pp. 511-579. 

Thirteenth Census. Vol. v. Agriculture. 

Coulter, J. L. Cooperation among Farmers. 

Emery, H. C. Speculation on the Stock and Produce Exchanges of the United 
States. 

Haggard, H. R. Rural England. 

Herrick, M. T., and Ingalls, R. Rural Credits: Land and Cooperative. 

Jebb, L. The Small Holdings of England. 

Marshall, Alfred. Principles of Economics, 6th ed.. Book vi. Chap. x. 

Mill, J. S. Principles of Political Economy, Book ii, Chaps, vi-x. 

MoRMAN, J. B. Principles of Rural Credits (with bibliography). 

Prothero, R. E. English Farming, Past and Present. 

U. S. Department of Agriculture. Year Book; The Crop Reporter. 

Industrial Commission. Report, Vols, vi, x, xi, xix. 

Rogers, A. S. L. The Business Side of Agriculture. 

RowNTREE, B. S. Land and Labour: Lessons from Belgium. 

Taylor, H. C. Agricultural Economics ; and "The Decline of Landowning 
Farmers in England," Bulletin of the University of Wisconsin, No. 96. 

Warren, G. F. Farm Management. 

Weld, L. D. H. The Marketing of Farm Products. 



CHAPTER XXX 
SOCIALISM 

Socialism Defined. — Socialists seek the establishment of in- 
dustrial democracy through the instrumentality of the State. 
Our political organization is to become also an economic indus- 
trial organization. Socialism contemplates an expansion of the 
business functions of government until the more important 
businesses are absorbed. Private property in income-yielding 
capital and land is to be abolished. Socialists make no war 
upon capital ; what they object to is the private capitalist. 
They desire to socialize capital and to abolish capitalists as a 
distinct class. Their ideal, then, is not, as is supposed by the 
uninformed, an equal division of existing wealth, but a change 
in the fundamental conditions governing the acquisition of 
incomes. 

Socialists usually say that labor creates all wealth. Land 
and capital, they hold, are merely passive factors of production, 
and their owners ought not to receive a share of the product 
unless they personally are useful members of the community. 
Labor is the active factor, and all production is carried on for 
the sake of man. Land and capital are simply the tools of 
man. Socialists admit that the owners of these tools must 
receive a return for them when industry is organized as it is 
now ; hence they desire that these tools should become public 
property. They wish to make of universal application the 
command of the Apostle Paul, " If a man will not work, neither 
let him eat." 

Distributive Justice. — Socialists, in common with a great 
many other people who do not accept their attitude toward the 
organization of industry, desire distributive justice. As to what 
constitutes justice they are not wholly agreed, but there is 

627 



628 OUTLINES OF ECONOMICS 

among them a tendency to accept equality of needs rather than 
productivity as a basis. Some, it is true, have advocated an 
almost mechanical equality, but most socialists today would 
regard the question of a precise standard for the distribution of 
income as not of present importance. They are simply agreed 
in this, that the distribution of the present day is wholly unjust. 
They think that men today do not have equal chances in life 
and that there is too much special privilege. The rewards, they 
think, today go to those who are shrewd and cunning, who are 
skillful in manipulating stocks and bonds, or who are favored 
by inheritance with a good start, rather than to those who 
render great social service. The inventors, poets, authors, 
scientists, skilled mechanics, and factory managers, they allege, 
are the large producers, but they do not get the big prizes. 

Varieties of Socialism. — The foregoing characterization ap- 
plies to most persons who have been called socialists, but the 
genus contains a number of species which should be distinguished. 

I. One group has been called " Utopian." This first group 
contains those who have become impressed with the evils of the 
present competitive system and propose the collective owner- 
ship of the means of production as a remedy, in much the same 
spirit with which a physician writes a prescription to cure his 
patient. There have been many attempts to picture to us how 
smoothly things would proceed if men could only be persuaded 
to adopt the collective ownership of land and capital. As a type 
of this class we may take Robert Owen. His life was contem- 
poraneous with the Industrial Revolution in England, he him- 
self being a successful manufacturer. He saw with his own eyes 
the evils of unrestricted competition, and was filled with an 
earnest desire to better the condition of the working classes. 
He is remembered as a factory reformer and promoter of volun- 
tary co5peration, but yet he regarded these efforts as not suffi- 
ciently radical. He thought human nature must be reformed 
by careful training from childhood in an atmosphere of associa- 
tion, instead of in the self-seeking, commercial atmosphere 
which surrounded him. He spent his large fortune in an at- 
tempt to carry out his ideas regarding the reconstruction of 



SOCIALISM 629 

society. Among his projects was the founding of a colony at 
New Harmony, Indiana, where no private property or com- 
petition should exist. After a struggle of two years, the 
experiment ended, as most other similar enterprises have, a 
complete failure. In this group would also be placed Saint- 
Simon, Fourier, Cabet, Blanc,^ and Bellamy. 

2. The " Marxian " socialists call themselves " scientific," 
as distinguished from the idealistic writers just mentioned. 
They insist that they have no cure-all for the ills of society. 
Socialism in their eyes is, in the main, only an explanation of 
what is happening. The private capitalistic system is breaking 
down, they say, and the logical result must be the collective 
ownership of the means of production as the next stage in social 
evolution. They say that setting aside all question of " ought " 
or " desirability," collective ownership is coming, and we might 
as well adjust ourselves to it. The four leading features of the 
Marxian philosophy are : (i) the view of society as an evolu- 
tionary product ; (2) the economic interpretation of history, 
according to which our whole social life, including our ideas con- 
cerning religion, art, marriage, etc., are but a reflex of past and 
present economic conditions ; (3) the doctrine of surplus value, 
according to which the income of the capitalist class does not 
represent a return for the sacrifice of " abstinence " or " wait- 
ing," but results from the fact that through the ownership of 
the means of production its members can compel the laboring 
class to work a longer number of hours than is necessary to pro- 
duce the wages which the laborers receive, what is produced 
in this additional number of hours being the source of capitalist 
income ; and (4) the doctrine of 1,he class struggle, which finds 
a deep antagonism between the capitalist class and the laboring 
class, that can only result in the overthrow of tlie former. 
Most socialists now believe that this victory will be won with- 
out bloodshed, as a result of a gradual increase in the strength 
of the socialist party as a political organization. 

3. The Fabian Socialists, of whom the members of the 

1 Louis Blanc was less " Utopian" than the others. He was transitional and in 
reality paved the way for the German and later "scientific" movement. 



630 OUTLINES OF ECONOMICS 

Fabian Society of England are types, have disapproved both of 
the founding of Utopian settlements and of the philosophy of 
Marx. The aim of this society has been to spread socialistic 
ideas by the dissemination of knowledge on the subject, rather 
than by an organized political movement, advocating this or 
that reform as opportunity indicated. The membership has 
come largely from the educated middle class, and has never 
been very large, although the society has exercised a very great 
influence. Practically, the views of the more conservative 
socialists in France and Germany do not differ greatly from 
those of the Fabians. 

The following words of the late Jean Jaures on the method of 
realizing the socialist ideal are of interest in this connection : 

"All Socialists, indeed, some openly, others with infinite precautions, 
some with a mischievous Viennese good-nature, declare it to be untrue that, 
taken as a whole, the economic material condition of the proletariat is get- 
ting worse and worse. It must be conceded, after taking account of the 
tendency to sink and the tendency to rise, that in the immediate reality of 
life, the tendency to sink is not the stronger. Once this has been granted, 
it is no longer possible to repeat after Marx and Engels that the capitalist 
system will perish because it does not insure to those whom it exploits the 
minimum necessities of life. It follows from the same admission that it has 
also become puerile to expect that an economic cataclysm, menacing the 
proletariat in its very existence, will bring about, by the revolt of the instinct 
of self-preservation, the 'violent overthrow of the bourgeoisie.' 

"It is not by an unexpected counter-stroke of political agitation that the 
proletariat will gain supreme power, but by the methodical and legal organi- 
zation of its own forces under the law of the democracy and universal suf- 
frage. It is not by the collapse of the capitalistic bourgeoisie, but by the 
growth of the proletariat, that the Communist order will gradually install 
itself in our society." ^ 

4. The Christian socialists. About the middle of the nine- 
teenth century, such men as Kingsley, Maurice, and Hughes in 
England were much impressed by the misery of the poor, and 
they attacked the competitive system as being responsible for 
the evils which they saw. Voluntary cooperation and the ele- 
vation of the workingman's character seemed to them the proper 

1 Studies in Socialism (trans, by M. Minturn), pp. 167-169. 



SOCIALISM 631 

remedies. Thus their theories do not fall under the head of 
socialism as we have defined the term. There is another group 
who believe that the ideals of Christianity can only be realized 
through the abolition of private capitalism. In Germany and 
in France socialist movements have been organized by adherents 
of both Protestant and Catholic churches. In the United States 
there has been no similar movement, although we find the term 
Christian socialist occasionally employed. 

5. State socialism is a term frequently used in German dis- 
cussion to designate the views of those who favor an extension 
of the economic functions of government without any great 
change in existing class relations. 

6. " Socialism of the chair " {Kathedersozialismus) refers to 
the views of university professors, particularly in Germany, who 
have advocated State interference with property rights to any 
extent demanded by public welfare, and have opposed the 
laissez-faire doctrines of the older economists. These men are 
not to be classed as socialists, the term being used as a reproach 
by their conservative opponents, and the designation has now 
chiefly historical significance. 

7. Syndicalism may be mentioned here, although it is more 
akin to anarchism than to socialism, and is to be viewed as a 
form of labor organization. The term is derived from the 
French word for labor union. The syndicalists believe that 
the emancipation of the working classes is to be achieved, not 
through control of present government, but by means of the 
control of, first, industry and, second, government by labor 
unions. They advocate the use of general strikes and of other 
destructive tactics, such as sabotage. They are extremely 
pessimistic with respect to the outlook for the laboring classes. 
This doctrine had its highest development in France about 
1908 and has had some following in England and America. 
The tactics of Syndicalism are condemned by the American 
Socialist Party. 

Communism. — Communism was the term employed by Karl 
Marx to distinguish his own philosophy from the " Utopian " 
schemes of such men as Owen, which he termed socialistic. But 



632 OUTLINES OF ECONOMICS 

today the reverse has become the common usage. Communism 
now very generally signifies the abolition of private property 
not only in production goods, but also in consumption goods, 
whereas socialists contemplate the retention of private property 
in income. In this case there would be provision of private 
property for every one, and in this one respect socialists em- 
phasize and extend the idea of private property. 

Socialism an Extension of Existing Institutions. — Our govern- 
ment owns the post office ; most governments the telegraph. 
Nearly all own the wagon roads. Some own the canals and rail- 
ways. Many governments own factories. Probably every 
national government does at least a little manufacturing. Most 
governments cultivate forests, and some cultivate arable land. 
We have only to imagine an extension of what already exists 
until government enterprise dominates in manufactures, mining, 
transportation, commerce, and carries on, in short, most pro- 
ductive enterprises, and we have socialism. 

But saying that socialism is an extension of existing institu- 
tions may lead to a misconception. The elimination of private 
capitalism, it is supposed, would work a most radical change in 
many branches of our social life. The commercial spirit, social- 
ists think, would be abolished, and with it all that is dependent 
upon it. We are trained today from childhood up, it is alleged, 
to try to " make money," and this accentuates the selfish 
elements in our nature ; and it is therefore maintained that our 
present system does nothing to promote, and does much to 
hinder, the development of the brotherly spirit. 

The Strength of Socialism. — - Socialism makes perhaps its 
strongest claim in its plea, first, for a scientific organization of 
the productive forces of society, and second, for a just distribu- 
tion of the annual social income. It is said that the present 
production of economic goods is small in proportion to popula- 
tion, but the socialist replies : " Naturally enough. Competition 
is wasteful. Two railways are built where one would suffice. 
Two trains run parallel between two cities where one would 
serve the public equally well. Three times as many mUk 
wagons, horses, and drivers are required to serve the people 



SOCIALISM 633 

with milk as would suffice if the milk business were organized 
like the mail distribution in cities. Look at the shops, whole- 
sale and retail, and see the waste of human force. Without 
competition, the dry goods business and the grocery business 
could be carried on with a third of the present expenditure 
of energy. Reflect on all the idle classes in modern society. 
Socialism would set everybody to work, and, making each one 
dependent on his own exertions for success, would stimulate all 
energies." The argument is a telling one, but it does not prove 
its point unless we grant that the present waste and idleness 
cannot be suppressed or greatly diminished without a departure 
from the fundamental principles of our present industrial order, 
or that the waste and idleness are not counterbalanced by 
advantages. 

Justice is a strong plea in the socialist philosophy. It cannot 
be for one moment claimed that each one's income is at present 
in proportion to his services to humanity. Income in proportion — 
to industrial merit is attractive to an ethical sentiment. But 
cannot we approximate justice in distribution on the basis of 
the existing order? There is nothing distinctively socialistic 
about the desire for distributive justice. It is a feeling that 
actuates those who work for the control of monopolies, for tax 
reform, for regulation of inheritances, and for labor legislation. 
The socialist simply differs from these people in his method of ;' 
attaining his ideal. 

The socialist criticism of the present regime is especially severe 
in the matter of unemployment. There are always some men 
able and willing to work who are seeking employment, and 
periodically, with the coming of crises and depressions, the lack 
of employment becomes widespread. Again, it is urged that 
today goods are made for sale, not for use, as they would be 
under the socialistic regime. Adulteration, deception, and 
" cheap and nasty " goods are the direct outcome of a system 
of private capitalism. In the socialistic state we are told the 
business of the shopkeeper is to help you find what you really 
need ; at the present time it is to his interest to persuade you 
to buy what you do not need or what will give him the greatest 



634 OUTLINES OF ECONOMICS 

profit. The spirit of competition is to the sociahst simply war- 
fare. In every business establishment a good part of the most 
highly paid labor is devoted, not to the production of goods, but 
to finding a market. Ability to fight one's competitor is quite 
as essential in business as is the ability to turn out good products. 

The Weakness of Socialism. — i. Strong as may be the fore- 
going indictment of the existing industrial system, it is not suffi- 
cient to indicate that socialism is to be the necessary or the desir- 
able outcome. The modern machine age is little more than a 
century old, and some of its most important phases are very 
recent. The dire predictions made by Karl Marx and his fol- 
lowers on the strength of some of the earliest phenomena of the 
factory system have not been borne out, and similarly the evils 
of today may possibly be very largely eliminated without de- 
parting from our fundamental institutions. In short, the first 
weak point in the socialist's position is that he attempts to pre- 
dict the course of economic evolution too far in advance. That 
we shall have a juster distribution of wealth in the future, and 
that we shall eliminate many of the present wastes of production 
seems probable, but whether this will be accomplished by a 
socialistic organization it would be very hazardous to predict. 
It is desirable to have ideals to work toward, but we should not 
pin our faith now to a future method for attaining them, for no 
one can say that the collective ownership of all of the important 
means of production presents a question that needs to be 
decided now. 

2. The socialist underestimates the efficiency of the present 
system. In particular he fails to see the significance of the great 
and (in many respects) smoothly-working system of economic 
cooperation that has resulted from giving opportunity to free 
individual enterprise. To-day there is a premium on energy 
and thrift. Much may be wasted, but much is also produced. 
That socialism would result in a larger sum total of goods for 
consumption has never been proved. But, on the other hand, 
we can say that the present regime is continually offering more 
and more to the mass of the people. Their standard of life is 
continually rising. Our economic world is a bettering world. 



SOCIALISM 635 

3. The socialist is also in other respects too pessimistic with 
respect to the present. He sees all of the starvation, misery, 
luxury, and extravagance, but he passes by the millions of happ); 
homes scattered throughout the land. He does not see that the "] 
world is full of opportunity for the rising generation, that even 

if the chance for the ownership of an independent business for the 
ordinary man is smaller, the things which he can enjoy, if he is 
of average intelligence and energy, are much greater than ever 
before in the world's history. — ' 

4. The socialist underestimates the importance of individual 
responsibility. Today a man is confronted by the stern neces- 
sity of making his own way, and this must have some good effect 
upon character. On the whole, the lazy and incompetent are 
sifted out. Bad heredity and a lack of proper training are the ^ 
cause of a good part of economic misfortune. It is well to dis- 
tinguish the criticism here made from the common error of 
supposing that socialism would necessarily crush individuality 
and that all would be compelled to dress and eat alike. 

5. The socialist underestimates the importance of free enter- 
prise in industry. If a man now believes that he can develop 
a certain industry that will satisfy important wants of the people 
in the future, he does not need to secure the consent of some 
government official to make the experiment. The possibilities ' ^ 
of a free and spontaneous development should be safeguarded 
from governmental routine to every possible extent. 

6. Perhaps the most frequently mentioned objection to social- 
ism is the danger to liberty. Under socialism there would be 
simply the public sphere of employment, and there is reason to 
fear that the inability to escape from the public sphere would 
compel the submission to onerous and tyrannical conditions 
imposed by the administrative heads of the business in which 
one might be engaged. The socialists, it is true, have a re- 
joinder in the fact that this objection refers to liberty in the 
negative sense of freedom from interference rather than in the 
positive sense of the power to have and to enjoy goods, and yet 1 
there are many persons who fear the tyranny of the majority. 
Those in whose hands political and economic control centered 



r 



636 OUTLINES OF ECONOMICS 

would have tremendous power, however they might be selected 
or appointed. As in the religious sphere in the past, so in the 
economic sphere in the future, we may find that compulsory 
cooperation is incompatible with human nature. 

7. The Marxian socialists may be criticized for the impor- 
tance which they attach to the economic interpretation of his- 
tory, for the validity of that proposition does not establish the 
validity of the socialist contention. Even if it be true that our 
social life is a reflex of our economic activity, it still does not 
necessarily follow that our economic development is going to be 
such as will land us in socialism. Their doctrine of the class 
struggle also does not give an accurate account of existing con- 
ditions. We have a laboring class and a capitalist class, it is 
true, but there is also a considerable class, perhaps large enough 
to hold the balance of power between the other two, which does 
not sympathize exclusively with either laborers or capitalists. 
Moreover, we have yet other social classes, divided from one 
another by lines that cut across those separating the capitalists 
and the laborers. Race is, for example, the basis of a social 
classification that lessens the unity and cohesiveness of the 
) laboring class. 

Social Reform. — There are those who recognize the strength 
of the socialist's criticism of the existing economic and social 
order, but who believe it wise^to attack the various problems 
confronting us one at a time. Social reform seems likely to 
accomplish more valuable results than socialism. We have a 
monopoly problem before us now. Its solution may involve a 
considerable extension of government enterprise. Why not con- 
centrate our efforts upon that problem instead of making up 
our minds now whether some day the greater proportion of the 
industrial field must be collectively owned and managed? 

The Socialist Movement. — In every country of importance 
at the present time there is an organized socialist movement. 
In Germany the Social-democratic party is the largest political 
party of the empire, having polled over one third of the total 
votes cast in 1812, although it has less than 28 per cent of the 
seats in the Reichstag. The growth in votes and representation 
is shown in the following table : 



SOCIALISM 



637 



Year 


Socialist Vote in Germany 


Representatives 
IN Reichstag! 


1878 


437,100 


9 


1881 


312,000 


12 


1884 


550,000 


24 


1887 


763,100 


II 


1890 


1,427,300 


35 


1893 


1,786,700 


44 


1898 


2,107,100 


56 


1903 


3,010,800 


81 


1907 


3,259,000 


43 


1912 


4,250,400 


no 



Although the official platform of the party adheres strictly to 
the orthodox Marxian faith, the party itself has worked for 
many reforms tending to favor the lower classes, and a large 
element of the party (the " revisionist " wing) is in favor of 
putting the doctrine of the class struggle and complete collec- 
tivism in the background, and laying main emphasis for the 
present upon social reform. In France there are a number of 
socialist factions of various degrees of radicalism, nominally 
united in one party, the factional strife being one of the promi- 
nent characteristics of the movement in that country. Their 
combined representation in the Chamber of Deputies is about 
one sixth of the total membership. A member of the moderate 
group, Millerand, was made Minister of Commerce (1899) in 
the Waldeck-Rousseau cabinet. Since that time other social- 
ists have accepted cabinet portfolios, but as individuals and not 
as representatives of the socialist party. In a number of French 
municipalities the government is almost completely socialistic 
in personnel. The result in these cases has been an increased 
public activity in behalf of workingmen, the poor, and the un- 
fortunate. 

In Belgium the success of the socialist party in promoting the 
cooperative movement has been striking. In England no one 
socialist party has attained the prominence of those in Germany 

' The total number of seats in the Reichstag is 307. 



638 OUTLINES OF ECONOMICS 

and France. Some of the socialist organizations have joined 
with the trade unions in forming a Labor Party, which in 1914 
had 39 representatives in Parliament. In the United States 
there are two rival parties, the Socialist party and the Socialist 
Labor party (of minor importance), both having platforms based 
upon the Marxian philosophy. The list of socialist ofi&cials in 
the United States in 1913 included 21 members of State legisla- 
tures, 34 mayors, and 612 municipal, county, and school officers. 
In 191 2 a socialist was elected to Congress from Wisconsin. 
The elections of 19 14 also resulted in the choice of one socialist 
member of Congress (from New York). In 191 2 the presidential 
candidates of the two socialist parties polled 6.3 per cent of the 
total vote, the total socialist vote at four recent presidential 
elections being : 1900,130,336; 1904,441,776; 1908,438,509; 
1912, 93i)4o6. 

Socialists have rendered good service by calling attention to 
social problems, by forcing us to reflect on the condition of the 
less fortunate classes, by quickening our consciences ; also by 
helping us to form the habit, acquired by few as yet, of looking 
at all questions from the standpoint of the public welfare and 
not merely of individual gain ; finally, by calling our attention 
to the nature of the industrial functions of government and 
helping us to separate rationally the private industrial sphere 
from the public industrial sphere. A number of questions hav- 
ing no connection with socialism have been, even by socialists, 
not infrequently associated with it. Atheism and free love may 
be mentioned. Socialists generally, however, regard religion 
and marriage as changing institutions. 

Anarchism. — In contrast with the socialist, the anarchist 
holds that the ideal social arrangement is that men should freely 
and spontaneously form cooperative groups. The anarchists 
attack government and deny the right of one man to exercise 
authority over another. Freedom, independence, self-reliance, 
non-compulsion, are what appeal to them. Such an ideal con- 
tains nothing reprehensible, but its complete attainment is im- 
possible. Some governmental compulsion seems necessary with 
human nature as it is or is ever likely to be. The anarchist is 



SOCIALISM 639 

not opposed to the principle of association ; he simply asks that 
the association be voluntary. The anarchist ideal is thus por- 
trayed by Kropotkin : 

"This society will be composed of a multitude of associations federated 
for all the purposes which require federation ; trade federations for produc- 
tions of all sorts, — agricultural, industrial, intellectual, artistic ; communes 
for consumption, making provision for dwellings, gasworks, supplies of food, 
sanitary arrangements, etc. ; federations of communes, among themselves, 
and federations of communes with trade organizations; and finally, wider 
groups covering all the country, or several countries, composed of men who 
collaborate for the satisfaction of such economic, intellectual, artistic, and 
moral needs as are not limited to a given territory. All these will combine 
directly by means of free agreements between them, just as the railway 
companies or the postal departments of different countries cooperate now, 
without having a central railway or postal government, — even though the 
former are actuated b)^ merely egotistic aims, and the latter belong to differ- 
ent and often hostile states ; or as meteorologists, the Alpine clubs, the life- 
boat stations in Great Britain, the cyclists, the teachers, and so on, com- 
bine for all sorts of work in common, for intellectual pursuits or simply for 
pleasure." ^ 

Many persons class anarchists and socialists together as simply 
dangerous persons. One thing they do have in common, and 
that is, discontent with existing conditions. Otherwise their 
views are in most respects radically divergent. 

Anarchists differ among themselves. The " communist- 
anarchist " Kropotkin has advocated revolutionary tactics. 
Bakunine and Stirner also favored the use of violence. The 
" individualistic anarchists," such as Tolstoi and Tucker, have 
advocated a peaceful policy of non-resistance. Godwin and 
Proudhon may be called anarchistic reformers. 

QUESTIONS AND EXERCISES 

1. Is the public purchase of a street-railway system socialistic? 

2. What is the attitude of socialists toward the trust problem? 

3. Compare the Amana Society with the New Harmony Community. 

4. What is meant by the economic interpretation of history? Is it ac- 
cepted by thinkers who are not socialists? 

5. Can the socialist be said to have a distinctive attitude towards war? 

* Memoirs of a Revolutionist, pp. 398-399- 



640 OUTLINES OF ECONOMICS 

6. What is the relation between trade-unionism and socialism in the 
United States? 

7. How should one measure the real cost of the supply of capital in a 
sociahstic state? 

REFERENCES 

Barker, J. E. British Socialism. 

Cross, I. B. The Essentials of Socialism. 

Ely, R. T. Socialism and Social Reform; French and German Socialism. 

Eltzbacher, Paul. Anarchism. (Trans, by S. T. Bjdngton.) 

Ensor, R. C. K. (Editor). Modern Socialism, 2d ed. (A collection of 

essays by leading socialists.) 
HiLLQUiT, Morris. History of Socialism in the United States. 
Hinds, W. A. American Communities. (Descriptive.) 
HuGHAN, J. W. The Facts of Socialism. 

Jaures, Jean. Studies in Socialism. (Trans, by M. Minturn.) 
KiRKUP, Thomas. History of Socialisjn. 
Kropotkin, p. Modern Science and Anarchism. 
Le Rossignol, J. E. Orthodox Socialism. 
Morris, William. News from Nowhere. 
Orth, S. p. Socialism and Democracy in Europe. 
Rae, John. Contemporary Socialism, 2d ed. 
Seligman, E. R. a. The Economic Interpretation of History. 
SiMKHOViTCH, V. G. Marxism vs. Socialism. 
Skelton, O. D. Socialism: A Critical Analysis. 
Socialist Party Campaign Book. 

Spargo, John. Syndicalism, Industrial Unionism, and Socialism. 
Tucker, Benjamin. Instead of a Book, 2d ed. 
VizETELLY, E. A. The Anarchists. 

Walling, W. E. Socialism As It Is; The Larger Aspects of Socialism. 
Wells, H. G. A Modern Utopia; Socialism and the Great State. 
Zenker, E. V. Anarchism. 



BOOK III 
PUBLIC FINANCE 



CHAPTER XXXI 
PUBLIC EXPENDITURES 

Nature and Significance of Public Finance. — Public finance 
deals with the revenues of government, with their expenditure, and 
their administration. Public finance is one part of economics. 
Like general economics, it deals with the means for the satisfac- 
tion of human wants. Some of our wants we satisfy in one way, 
some in another. Some we satisfy individually. Some we 
satisfy through private associated effort, especially through the 
private corporation. Others we satisfy through public collective 
effort, that is to say, through some governmental agency. The 
wants which we satisfy through governmental agency are not all 
of them so peculiar that they could not be satisfied either through 
private individual activity or private associated activity. Let us 
take the case of watering the streets. There are places in which 
the streets, in so far as they are watered at all, are watered by in- 
dividuals in their private capacity, each man watering the street 
in front of his own house with his own hose. There are other 
places in which the householders join together and pay some 
one to water the streets for them, and do this privately. There 
are still other cities in which the city government employs persons 
to water the streets and pays them from the proceeds of taxation. 

There are, to be sure, some wants which are satisfied through 
governmental agency and which a civilized community will not 
allow us to satisfy privately. This is the case with those wants 
which are satisfied by means of the police and the courts. It i? 
a peculiar function of government in modern times to provide the 
inestimable blessing that we call security of person and property. 
This requires economic resources, just as the satisfaction of the 
other wants mentioned does, and public finance has to do with 
the provision of these resources. 

643 



644 OUTLINES OF ECONOMICS 

Public finance, then, is a part of economics because it deals 
with the satisfaction of wants by the use of economic resources. 
It is also a part of economics because it has its influence upon the 
production, the distribution, and the consumption of wealth. 
But while we have to insist that public finance belongs to eco- 
nomics, it is more separated from the other parts of economics 
than they are from each other. Inasmuch as it deals with the 
satisfaction of wants through governmental agency, it has its 
own peculiarities, and it is only an undue emphasis upon these 
peculiarities which leads some writers to, make it a separate 
science. 

The significance of public finance may be brought before us 
by examination of, first, the increasing amount of public revenues, 
and of, second, the enormous aggregate of these revenues at the 
present time. Public revenues have gone on increasing during 
the past hundred years by leaps and bounds. An illustration is 
afforded by the history of France. Ninety years ago the public 
expenditures of France reached one thousand million francs for 
the first time, or, as we generally say, a billion francs. There 
was universal astonishment and alarm, just as there was when, 
for the first time, an American Congress spent a thousand million 
dollars in two years. Never since the time,. however, when the 
public expenditures of France first amounted to a thousand mil- 
lion francs have they been so small. Gradually they increased 
until they reached two thousand millions, never to pass below 
that mark ; then they increased until they touched three thou- 
sand millions ; and now the national expenditures are nearly four 
thousand millions. Public expenditures at the present time, 
under the modern government, amount to more than a tenth part 
of all the wealth produced.'^ 

1 This estimate (that public expenditures equal one tenth part of all the wealth 
annually produced) has been given, but it must be a very considerable underestimate 
for the modern nation. We in reality know very Httle about the amount of wealth 
annually produced in the modern nations of the world. But such data as we have, 
and familiar observation, are sufficient' to convince us that the wealth produced is 
not ten times the total pubHc expenditures. In the United States, according to 
Starke M. Grogan, chief (Census) Statistician in Charge of Wealth, Debt, and Taxa- 
tion, the total expenditures or "total governmental cost payments," including the 



PUBLIC EXPENDITURES 645 

Now what does this mean ? Does it signify increasing extrav- 
agance or even corruption? Quite the contrary. While the 
modern government is far from perfect, it is throughout the 
civilized world probably better than it ever has been before. 
Taking the civilized world as a whole, there probably never was 
more honest government or more efhcient government than there 
is today. What it really means is this : We are living in a pe- 
riod of increasing public cooperation. We think we find it more 
advantageous to satisfy certain wants, growing in number and 
significance, through public cooperation than through individual 
effort or private cooperation. This is the chief significance of 
the increasing governmental budget throughout the civilized 
world. Mihtarism in its various phases is the chief phase of pub- 
lic expenditures that is disquieting.^ Educational expenditures 
afford a good illustration of the general tendency. They run 
up into the hundred millions in the modern nation, whereas, 
previously to this century, they were insignificant. Expendi- 
tures for police protection, for public lighting, and for sanitation 
are things which, so far as any expenditures of magnitude are 
concerned, belong to this century. 

Public finance has still another significance. Questions of 
social reform are now connected generally with financial ques- 
tions just as formerly they were with constitutional questions. 
Public finance has become the central fighting place for social 
reform. The question of protection has, from the earliest days 
in this country, been connected with public finance. Police 
regulation has also been connected with fiscal measures. The 
license charge for the privilege of selling alcoholic beverages 

national government, states, territories and local subdivisions amounted in 1913 to 
$3,284,343,266 or $33.83 per capita. Professor W. I. King {Wealth and Income of the 
People of the United States, p. 248) estimates the average income in the United States, 
for the year 1910, at $332 per capita. Public expenditures thus appear to take about 
10 per cent of the income in this country. In England the per capita expenditure of 
the national government alone was, before the European War, over $15-5°, and in 
France over $17. The 10 per cent estimate, then, is clearly an underestimate for 
most countries. 

1 This topic is adequately treated by Professor Charles J. Bullock in his article 
entitled "The Growth of Federal Expenditures," Political Science Quarterly, vol. 
xviii, pp. 97-1 1 1. 



646 OUTLINES OF ECONOMICS 

furnishes an illustration. The scope of the police power is 
expanding in the United States, and this means expansion of the 
field of public finance. The discussion of public expenditures 
reveals, as few other subjects do, the nature of our civiliza- 
tion. 

Public and Private Expenditures Contrasted. — There is a 
difference between public and private economies with respect 
to the equilibrium between income and outgo. Relatively, 
there is an elasticity of government revenues and an inelasticity 
of government expenditures. This finds expression in the state- 
ment that public revenues are gauged acccording to expenditures ; 
whereas, in the private economy, the household expenditures are 
regulated by income. This is a regular rule for normal conditions. 
It is abnormal when irregularities in public income lead to irregu- 
larities in expenditures. It has been observed by a critic that 
this principle of public finance is true in a legal sense, but not in 
an economic sense. It is said that when public expenditure is 
decided upon, then we legally determine the income ; but, eco- 
nomically, the expenditures of the state rest upon a foundation 
as elastic as that of a private person.^ It is true that in public 
expenditures there must be a balancing of gain and sacrifice, and 
that in the case of a particular expenditure it must be weighed 
over against all other possible expenditures, not only public, but 
private. The rich state, undoubtedly, will incur expenditures 
from which a poor but prudent people will probably shrink. On 
the other hand, a private person is not to be thought of as neces- 
sarily spending all his income, even if he gauges his expendi- 
tures by income. 

Nevertheless, roughly speaking, the principle has significance 
because of the priority of the claims of the State. This has been 
well brought out by critics of Henry George, who advocated the 
appropriation of economic rent for public expenditures. Some 
of Mr. George's followers have replied to the objection that eco- 
nomic rent might not be sufficient for public expenditures : 
" Then the State must curtail its expenditures as the private person 
would do." When we think about it, we find that certain public 

* Gustav Cohn, Finanzwissenschaft, S. 184. 



PUBLIC EXPENDITURES 647 

expenditures must be made and must take prior claim. How- 
ever, when, as is so often the case in cities, there is an income 
strictly limited by the tax rate, we have a situation like that of 
a man with a limited and inadequate income. This is an un- 
fortunate situation for cities ; but the case of a national govern- 
ment which did not have a prior claim upon wealth for defense 
would be anomalous. 

Closely connected with what has been said, we find various 
differences due to the sovereignty of the State and its perpetual 
life. The State orders a citizen to give up a part of his possessions, 
and, indeed, frequently fixes the prices to be paid for them. And 
a peculiarity of the prices paid by all states for property and 
services is that they must be determined by criteria of fairness, 
inasmuch as by the very hypothesis competition is wanting 
wholly or in part. Consequently, we find courts and legislatures 
much occupied with the determination of what is " fair and rea- 
sonable." The perpetual life of the State has to be kept in mind 
in a great variety of expenditures. It is the special function of 
the State to provide for future generations, and this is seen, for 
example, in forestry and in care for rivers and harbors. 

There is a difference between public and private economies in 
the means of measuring the utilities resulting from expenditures. 
It is at once admitted that all expenditures of states and of pri- 
vate persons should, in a large sense, be productive. Waste is 
everywhere an economic wrong, but productive expenditures 
mean simply useful expenditures. What the State produces is 
largely immaterial services, and these have no market price. 
How can we tell whether they are socially profitable or unprofit- 
able? They are not worth while if they result in a sacrifice of 
other expenditures which would yield larger satisfactions. It is 
a special function of the legislative body, in a constitutional 
state, to decide upon the relative advantages of various possible 
public expenditures, and to weigh these over against the ad- 
vantages of private expenditures which might have been made 
if the money permitting the expenditures had been left in private 
pockets. When a certain sum is taken from me by taxation, it 
results in a public expenditure instead of a private expenditure 



648 OUTLINES OF ECONOMICS 

which might have been made. This is only another way of 
saying that public expenditures are largely from income which 
is derivative. Private individuals secure an income and then 
yield a part of it for public purposes. These contributions are 
compulsory. On the other hand, there are economists who look 
upon the State as a factor in production, and hold that what is 
paid in taxes is less than what corresponds to the cooperative 
activity of the State in the maintenance of law and order and in 
other services. The special social significance of public expendi- 
tures is that their aim is inclusive^ normally and regularly; 
whereas, normally and regularly, the aims of private expendi- 
tures are more or less exclusive. A public library contrasted 
with a scholar's private collection of books illustrates this point. 

All these differences are considerable, and they give us perhaps 
at least one reason why business men are so often a disappoint- 
ment in an official capacity. The public financier must be gov- 
erned by the public point of view.; and there are many points at 
which this diverges from the private point of view. The true 
statesman is one who has the public point of view, and yet is 
able to avail himself of the knowledge and experience of private 
business. 

The Proper Proportion between the Total Income of Society 
and Public Expenditures. — We notice actual changes in this 
proportion, and we discover that further changes are advocate4, 
running all the way from anarchism, which would abolish gov- 
ernment and public expenditures, to socialism, which, by making 
production and distribution public functions, would make public 
expenditures, broadly construed, nearly equal to the total wealth 
production. 

An attempt has been made by those who take a less extreme 
position than either of these to give an estimate of what is a large 
public expenditure, what a small expenditure, what is desirable, 
undesirable, or even intolerable. Generally these estimates are 
made with respect to the maximum expenditure, but we could 
equally well raise the question with respect to the minimum. 
One writer speaks of public expenditures of 16 per cent as aver- 
age, and 25 per cent as excessive. Another regards public ex- 



PUBLIC EXPENDITURES 649 

penditures which consume 1 5 per cent of the total annual wealth 
production as the upper limit. In our American practice, we 
very generally attempt to fix a maximum direct tax rate. 
But these limits are based on the valuation of property and not 
on income. State constitutions very frequently also limit state 
expenditures, as well as the expenditures of cities and other local 
units. For local purposes in the United States, we have roughly 
a tax limit of | to 3 per cent of the value of property. Total 
taxation of real property frequently runs in the United States 
from 10 per cent to even 20 per cent of the net profits, and indeed 
not infrequently goes far beyond that. The truth is that it is 
absolutely impossible to give any general answer to the question, 
" What is the proper proportion between the total income of 
society and public expenditures? " Variations in- the wealth of 
a country have to be considered, and these mean much when the 
question of additional expenditure is raised. Variations in tax 
systems and the consequent distribution of the burden of taxa- 
tion make a wide difference. In times of distress, more can be 
expended than on ordinary occasions. When the national life 
of the State is endangered in a war, expenditures will be incurred 
which would be impossible at any other time, simply because for 
any other reason the people would not submit to the sacrifice 
involved. 

But there are other points of view which go still deeper. Why 
do we spend money at all through the State ? Obviously to sat- 
isfy needs. How much we should spend publicly depends upon 
what needs are satisfied publicly. We have to ask and answer 
the question, " What position do these needs hold among our 
needs in general? " " Do they belong to our necessities or 
superfluities? " When we consider public expenditures in the 
broadest terms, we must take into account the amount of pro- 
duction which is carried on by the State — employing this term 
" State " here as elsewhere in its generic sense. If the railways 
(as in Germany) are state railways, a larger percentage of the 
expenditures and revenues of the country are public in character 
than would be the case if they were privately owned and operated. 
No comparison of expenditures of various countries can have any 



650 OUTLINES OF ECONOMICS 

value if it does not take into account considerations of this 
kind. 

Professor Adolph Wagner ^ lays down this rule, which is help- 
ful in answering the question as to the proper proportion between 
the income of society and public expenditures for any particular 
time and place : " The permissible amount of public expendi- 
tures, both absolutely and relatively considered, will vary di- 
rectly in proportion to (a) the direct economic value of state activi- 
ties ; (b) the extent to which these promote the productive power 
of all ; (c) the absolutely free social income ; ^ (d) the part of the 
net state receipts coming from the quasi-private acquisition 
(railways, industries in general) of the State and not from taxes." ^ 
Fortunately, how much we shall spend presents itself historically, 
that is, with respect to historical conditions, and has reference to 
increments or decrements of expenditure. The problem is far 
easier of solution than it would be otherwise. 

In fact, except as a concrete historical problem, it is impossible 
to state how great the public expenditures should be. We are 
now in a position to understand why it is that the nations of the 
world have not been ruined by expenditures which even a genera- 
tion ago would have been thought absolutely crushing, and one 
hundred years ago would have been inconceivable. We satisfy 
our needs to an ever increasing extent through public agencies. 
This finds expression in the /aw of increasing public expendi- 
tures, given by the writer from whom we have just quoted. 

" Comparisons between different countries and different periods 
show regularly among progressive nations an extension of public 
activities. This manifests itself extensively and intensively. The 
State and its subordinate political units continually undertake new 
functions, and they perform their dtities, old and new, better and bet- 
ter. In this way, that is, through public agency, the needs of the 
population, especially their common needs, are satisfied to an in- 

1 Finanzwissenschaft, 2te A., Bd. i., S. 65. 

2 I.e. beyond and above what is needed for subsistence. 

' This means public ownership of enterprises which are so conducted as to yield 
profits. All the profits can and indeed must be expended for public purposes, 
whereas, if the industry were private, only a part of the profits could be taken for 
public purposes. 



PUBLIC EXPENDITURES 651 

creasing extent; and the public services for the satisfaction of needs 
continually improve in quality. The clear proof of this is given 
statistically in the increased demands made by the State and the 
subordinate political units J ^ ^ 

We have here described what is a part of a still larger move- 
ment, namely, the socialization of production and the socializa- 
tion of consumption. It is, however, the socialization of con- 
sumption which especially confronts us in public expenditures. 
To an increasing extent what is consumed by the family is pro- 
duced outside the family. There has been going forward a great 
process of socialization, and this finds expression in part in public 
expenditures. The needs of the family are satisfied, in increas- 
ing proportion, not by the private economy, but by the public 
economy, and satisfied also, as Professor Wagner points out, not 
in accordance with the principles of private economy, which is 
service for service, but in accordance with the principles of the 
public economy, which is an adequate general return for that 
which is received. 

We have to do with what we may also call socialization of sup- 
ply. We do not protect ourselves against physical violence, but 
are protected by the State. We do not educate our own children ; 
they are educated by public agency. And public expenditures 
are also made to promote art and all the higher interests of life. 
The services which the federal government renders us in the post 
office find expression in public expenditures. Public expenditures 
are giving us more beautiful and more healthful cities, and are 
satisfying the needs which arise out of the extensive growth of 
the country, in its expansion geographically and in the size of the 
population, and also the needs which arise from an intensive 
growth. 

The significance of this lies partly in increased state activities 
and partly in the incidence of the cost of the services under con- 
sideration. The poor, who could not themselves have pleasure 
grounds, enjoy public parks, and these are maintained at public 
expense. So we may take up one service after another and find 
that wealth, produced in accordance with the principles of the 

^ Wagner, Grundlegung der polUischen Oekonomie, 3te A., Bd. i, S. 893. 



652 ' OUTLINES OF ECONOMICS 

private economy, is consumed in accordance with the principles 
of the public economy, and that is very largely in accordance 
with needs and capacity for use. The whole public educational 
system, from the country district school to the modern state 
university, culminating in research and investigation, admirably 
illustrates this principle. 

Extravagance, Economy, and Parsimony in Public Expendi- 
tures. — After a definition of economy in Webster's International 
Dictionary, we find the following : " Economy, Frugality, Parsi- 
mony. Economy avoids all waste and extravagance, and applies 
money to the best advantage ; frugality cuts off indulgences, and 
proceeds on a system of saving. The latter conveys the idea of 
not using or spending superfluously, and is opposed to layishness 
or profusion. Frugality is usually applied to matters of con- 
sumption, and commonly points to simplicity of manners. 
Parsimony is frugality carried to an extreme, involving mean- 
ness of spirit and a sordid mode of living. Economy is a virtue 
and parsimony a vice." 

We must have clear ideas as to which course of the three we 
shall follow, for it is scarcely to be taken for granted that we shall 
follow the course of extravagance. There is, however, danger of 
indifference as to the size of public expenditures, and extrava- 
gance may result therefrom. While scarcely any one now would 
deliberately advocate extravagance so far as the general princi- 
ple is concerned, extravagance in detail might be advocated; 
and, in fact, in practice we find both indifference and extrava- 
gance. Sometimes the idea that extravagance brings money 
into circulation has found favor, and especially has been used 
for the justification of large expenditures by royal courts. The 
same idea has been used as- a justification for luxury. It can, 
however, find no support in economic principles. There is dan- 
ger of extravagance because each one concerned with govern- 
mental expenditures feels that what he spends is a relatively 
small matter, and indeed it is. It is sometimes thoughtlessly 
overlooked that when many are spending, " small waste " be- 
comes significant, and may be even ruinous. This is a problem 
which concerns every large business, and it requires strict and 



PUBLIC EXPENDITURES 653 

wise administration to avoid the two extremes of wasteful 
extravagance and red tape. 

Sectionalism also results in extravagance, and this shows itself 
badly in the United States at times. Whatever any state can se- 
cure from the federal treasury is often looked upon as so much 
clear gain. This was clearly brought out in the discussions con- 
cerning the repaym_ent, several years ago, of the direct tax that 
had been paid by the states to the federal government. This tax 
has now been repaid, but many states gave agents large and 
extravagant sums to work for the refund. Sometimes sectional- 
ism manifests itself even in cities. In one section of the city 
there may be vigorous efforts to secure money for itself without 
due regard for the general interest. 

For many years, in this country, federal taxes were laid very 
largely for other than revenue purposes, and there was no care- 
ful balancing over and against one another of probable revenues 
and probable expenditures, with the result that there was fre- 
quently a large surplus in the federal treasury. There never 
has been a time when it would not have been possible to have 
expended wisely the entire revenues of the federal government ; 
e.g. the telegraph might have been purchased, and educational 
expenditures might have been increased. But there was no 
demand for these expenditures strong enough to prevail, and the 
outlet was found along the lines of least resistance, or, perhaps it 
ought rather to be said, along the lines of greatest " pull." 
We may then lay it down as a general law that there is danger of 
extravagance whenever public revenues outrun felt needs. 

In the domain of local government it is possible to limit taxes 
or expenditures, and, as stated above, American statute books 
are full of laws prescribing maximum rates for school, highway, 
and other tax levies. These laws have failed in the past because 
they were adjusted to our prevailing underassessment of prop- 
erty and it was perfectly easy to evade them by raising the 
assessment a little closer to the true value. More recently, 
however, Colorado and several other states have adopted " tax 
limit laws " which work successfully. Instead of limiting tax 
rates, the total tax levy or the total expenditures are limited to a 



654 OUTLINES OF ECONOMICS 

certain increase, say ten per cent, over the tax levy or total 
expenditures of the previous year ; and some authority — 
usually the state tax commission — is empowered to raise the 
normal limit in " cases of emergency or urgent necessity." 
Tax limit laws applied in an arbitrary way may cripple, and in 
some cases have crippled, municipal governments in necessary 
and desirable expansions of public activity ; but when adminis- 
tered by a wise board or commission authorized to modify the 
ordinary limit when necessary, they are capable of restraining 
harmfully rapid expansion of public expenditures.^ 

There is a tendency, especially wherever public spirit is not 
highly developed, to favor parsimony, and to regard that as the 
best administration which spends least, and the smallest tax as 
the best tax. This idea was particularly encouraged by those 
who looked upon government expenditures as external to the 
life of the people — as if they were expenditures for some outside 
person. This idea, indeed, may be traced back to monarchical 
government and to a time when royal courts consumed a large 
part of the public revenue. The smallest expenditure means 
the accomplishment of the fewest purposes. Parsimony means 
meanness, and can never be the rule either of public or private 
financiering. Frugality is the rule when it is a necessity. Econ- 
omy is the sound rule ; and this means a broad and liberal policy 
and a husbanding of resources. The wise citizen judges any 
particular administration either in the nation or the state, not 
chiefly by the amount of public expenditures, but by the results 
of public expenditures, appreciating full well that increasing 
public expenditures are a normal condition in a sound and 
healthy society. 

The Development of Public Expenditures. — It is instructive 
to consider the historical order in which the objects of public 
expenditure appear. This order throws a strong light upon the 
evolution of industrial society and of civilization in general. 
This is an almost unworked field of investigation, but it is an 
extremely interesting and important one. This order can be 

1 See discussions of this subject in State and Local Taxation (Proceedings of the 
National Tax Association), Vol. viii, pp. 368-390, and Vol. ix, pp. 452-473. 



PUBLIC EXPENDITURES 655 

presented here only in the most general terms, and in these 
terms it is somewhat as follows : Expenditures for (i) external 
security; (2) security within the community; (3) promotion 
of material interests ; (4) benevolence (transferred in part from 
the Church at the time of the Reformation) ; (5) education in its 
various phases ; (6) labor. In a general way the organization 
of the departments of the federal government corresponds with 
this order. In 1789, the Treasury, War, and State departments 
were organized, also the Department of Justice, Supreme Court, 
and the Navy Department ; the Post Office Department was 
organized as a distinct department in 1829 ; the Department of 
the Interior was organized in 1849 J the Department of Labor 
as a separate department (without representation in the Cabinet) 
in 1889 ; the Department of Agriculture as a separate department 
(with representation in the Cabinet) in 1889 ; the Department of 
Commerce and Labor (with representation in the Cabinet) in 
1903. In 1 9 13 Commerce and Labor were divided and given 
separate representation in the Cabinet. The modern nation has 
been spending an increasing proportion of its resources for edu- 
cation. (We use " nation " in the general sense here, including 
all the subdivisions of the nation.) We find a rapidly increasing 
item in the budget of the modern municipality for public libraries, 
in which line of expenditure the United States is leading the 
world. Lately, in the modern budget, we find expenditures 
which are distinctively for the promotion of the interests of 
labor. 

Most interesting it is to observe, within the last few years, an 
expenditure in the national budgets for international agreements 
and arrangements to promote the interests of labor. In 1900, 
the International Association for Labor Legislation was formed, 
and its permanent Bureau was established at Basle, Switzerland, 
in 1 90 1. As the competition of labor and capital was interna- 
tional, it had, in the opinion of many careful observers, become 
necessary to safeguard the interests of labor by international 
agreements. Consequently, we find that this international 
association receives subsidies from most European governments, 
and a small one from the United States through our federal 



656 OUTLINES OF ECONOMICS 

Department of Labor. And, in 1905, as we have already seen, 
an international treaty was entered into by Italy and France 
for the advancement of the interests of labor and for mutual 
protection of employers. Small indeed are these items, but 
they are significant as beginnings. 

We must, however, analyze the public expenditures of the 
various departments more carefully to understand fully the order 
of development in the objects of public expenditures. The 
whole expenditure of the Department of Agriculture is an expen- 
diture to promote material well-being, and this has become one 
of the great departments in modern government. The Depart- 
ment of the Interior is also largely concerned with expenditures 
to promote the general material welfare. We have in the De- 
partment of Agriculture such divisions as forestry, food adultera- 
tion, botany, seed tests, pomology, entomology, agricultural 
soils, irrigation investigations, and road inquiry. , 

We cannot lay down any hard and fast line between public and 
private expenditures, because there is a perpetual shifting from 
the satisfaction of v/ants privately to the satisfaction of wants 
publicly, and sometimes even, though less frequently, the reverse 
process. The railways of Prussia were once private, and their 
receipts and expenditures had little to do with the Prussian 
budget. Now the receipts are public receipts, and their expen- 
ditures are public expenditiires. The addition to the budget, 
however, does not mean necessarily an additional burden on the 
people. Indeed, if the people are well served and served for a 
lower price than formerly, with less relative cost of operation, the 
burdens of the people have been lightened, and this is what is 
generally claimed in Prussia. Let us take the case of a city in 
which watering the streets is a private matter paid for by private 
subscription. The expenditure becomes a public expenditure 
when the city takes upon itself this function, but if the public 
expenditure is no greater than the private expenditure, there is 
no additional burden. If the service is better performed, and the 
total burden more fairly distributed by taxation than by private 
subscription, — as sometimes, at least, happens, — there is a 
positive gain. The increased density of population has been 



PUBLIC EXPENDITURES 657 

mentioned as a cause of increased public expenditures. A suburb 
without any municipal organization may maintain electric lights 
in the streets by private subscription. The expenditure appears 
in no public budget. This suburb secures some kind of a mu- 
nicipal organization, and that which was a private expenditure 
becomes a public expenditure. Again, however, there is no 
increased burden resting upon the people ; their wants are satis- 
fied through a different channel. 

When we compare modern times with ancient times, we 
find that an increasing proportion of the public expenditures 
are incurred for objects which directly benefit the people, and 
relatively a decreasing amount for objects in which they have 
comparatively little concern. This finds most striking exem- 
plification in a comparison of the budget of France in 1789 ^ 
with the budgets of 1906 and 1907, which we take merely as 
typical modern budgets.^ 



Expenses — 1789 


LiVRES 2 


Cost of collection and reimbursements (does not include cost 

of collecting taxes farmed out) 

Consolidated debt - — included portion made up of annuities 

Interest, etc., on remaining portion of debt 

Pensions 


31,478,000 
162,486,000 
80,527,000 
29,560,000 
33,240,000 


Royal family and princes 




Total 


337,291,000 





" This formed the total deduction before provision could be 
made for general service of the government," in which the vari- 
ous items are as shown in the accompanying table. It will be 
observed, in comparing these budgets, that the French court 
consumed a very large proportion of the expenditures of 1789; 
and that of what remained a very large proportion was consumed 
by the public debt, the army and navy ; and that for education 

1 Necker's "Budget," May, 1789, rearranged by the author of the article in the 
Dictionnaire des finances. 

* A livre is slightly — say 2 per cent — less than a franc. 

2V 



658 



OUTLINES OF ECONOMICS 



and the promotion of general welfare the expenditure was rela- 
tively insignificant. A study of the table on the next page re- 
veals one of the reasons why it is that France is able to sustain 
so large a public expenditure. Wants are thereby satisfied, 
and what is expended returns to the people in services. 



Expenses — 1789 {Continued) 



LiVRES 



War 

Marine and colonies 

Foreign affairs 

Justice 

Interior 

Financial administration 

Public works, agriculture, and commerce 
Public instruction and fine arts . 
Public worship 

Total 

Brought forward 

Grand Total 



100,548,000 
40,900,000 
7,480,000 
6,353,000 
8,249,000 
5,801,000 
11,907,000 
1,227,000 
2., 188,000 



184,653,000 
337,291,000 



521,944,000 



The view here presented of public expenditures is undoubtedly 
one which is reassuring. The impression must not be gathered 
from this that there is no need for care and watchfulness. As 
public expenditures increase, it becomes of more and more im- 
portance to secure wise and prudent administration of all our 
resources. Wastefulness becomes more serious than ever before, 
and the benefits from excellence in administration increase cor- 
respondingly. Without pronouncing any opinion upon what is 
called imperialism, we may also say that the enormous increase in 
expenditures, in one way or another connected with war, which 
we have seen during the past few years, cannot be viewed with- 
out misgiving. Even if there is no danger of the bankruptcy 
of any great modern nation, the thought must at least occur to 
one that it is a pity that, with so many public needs unsatisfied, 
with such large possibilities in the way of improvement of educa- 



PUBLIC EXPENDITURES 659 

Budget Estimates Voted for the Years 1913 and 1914 



Branches of Expenditure 



1913 

Francs 



1914 
Francs 



Finance : public debt . . . 
President, Chamber, Senate 

Finances 

Justice 

Foreign affairs 

Interior 

War 

Marine 

Merchant marine . . . . 

Instruction 

Fine arts 

Commerce and industry . . 

Labor, etc 

Posts and telegraphs . . . 

Colonies 

Agricvilture 

Public works 

Total 



3S8 



983 
467: 

309 
21 
16 

106 
344 
loS 
. 55 
340 



,423,922 
,116,488 
948,853 
1551,727 
,668,037 

961,939 
,224,376 
176,109 
394.631 
^139,995 
,778,491 
.792,379 
.669,353 

.313,845 
.535,393 
,002,741 

,905,255 



1,306,585,021 

20,006,738 

389,243,907 

61,017,461 

22,879,749 

176,949,513 

1,203,659,712 

513,542,521 

97,368,267 

347,810,375 

21,839,189 

17,948,374 
106,718,809 
362,635,135 
109,724,180 

74,769,222 
358,944,912 



4,738,603,534 



5,191,643,085 



tion and of our general environment, such enormous and almost 
incomprehensible aggregates of wealth should be annually ex- 
pended for warlike purposes. 

Development of Public Expenditures with Respect to Regu- 
larity and Irregularity. — Public expenditures are regular and 
irregular, or ordinary and extraordinary, with respect to their 
occurrence. Whether the expenditures are regular or not depends 
upon the nature of the goods and services for which they are in- 
curred. A large force must be employed in the army and navy 
and civil service ; and regular expenditures must be made for 
these branches of the public service. On the other hand, there 
are great monumental works like the construction of a capitol 
for which the expenditure is irregular in character. War, 
famine, and pestilence occasion irregular expenditures. It is to 
be noticed, however, that in any scientific arrangement regular 
expenditures increase and irregular expenditures decrease. This 



66o OUTLINES OF ECONOMICS 

is particularly the case in a large country, and especially so when 
long periods of time are taken into account. It is an end to be 
striven for in the interest of orderly finance. In India there is a 
regular famine fund to make provision for the recurring famines, 
so that even expenditure of this kind takes on the character of 
regularity. The longer the period of time and the larger and 
richer the country, the greater the possibilities of establishing 
regularity, inasmuch as chance elements decrease under these 
circumstances. The construction of a post-office building in one 
city is an unusual event, but, when the United States as a whole 
is taken into account, it is quite possible to provide regularly 
for post ofiice buildings. 

It is further to be noticed that preventive measures rather 
than relief measures increase regular expenditures. This is one 
argument in favor of constant preparation for war. The war 
expenditures are smaller and less disturbing when they come. 
It need not be remarked that this financial advantage may be 
secured at a loss otherwise. 'Furthermore, there is a certain con- 
flict of interests between administration and legislation. Those 
who are administratively responsible for expenditures prefer to 
have budgets voted for long periods, as in this way they can 
accomplish most with a given sum. On the other hand, a legisla- 
tive branch of government desires that budgets should be voted 
for short periods for the sake of stricter control. 

It is also to be noticed that the constitutional provisions 
against debts in the states of the American Union promote 
regular expenditures. Where loans are not possible, it is fre- 
quently necessary to spread expenditures over long periods in 
order that the burden may not be too great at any one time. 
This may happen in the construction of public buildings and of 
other important public works, certain sums being appropriated 
each year for a series of years. 

Classification of Public Expenditures. — Many principles of 
classification have been adopted. At the bases of all of these, for 
countries like our own organized along federal lines, is the dis- 
tinction among (i) central, (2) intermediate, and (3) local units. 
In the United States the central would be the federal, the inter- 



PUBLIC EXPENDITURES 66 1 

mediate would be the separate states, and the others, the local. 
An examination of expenditures with respect to these units 
throws a good deal of light upon our general political evolution. 
It especially helps us to determine whether or not there is a tend- 
ency in the direction of centralization, although expenditures 
are not conclusive evidence. Fear is often expressed lest the 
central governments should expand at the expense of local gov- 
ernments. It is thought by some that we are living in a period 
of centralization. Statistics of public expenditure do not bear 
this out. From the close of the Civil War until the end of the 
nineteenth century, local expenditures increased most rapidly 
and state expenditures least rapidly. Between 1903 and 191 3, 
however, the expenditures (" governmental cost payments ") of 
the states increased 106 per cent, while those of incorporated 
places with 8000 or more inhabitants increased only 103 per cent, 
and those of the federal government only 54 per cent. The 
increase in state expenditures seems to have been due to general 
expansion and multiplication of state activities, although it was 
particularly marked by the development of state highways and 
costly internal improvements such as the new canal system in 
New York, by more generous appropriations for education, and 
by the multiplication of state commissions.^ 

The student, and even the general reader, will find it especially instructive 
to study the financial reports of the federal government and of our states and 
cities, and arrange the items of expenditures under various general heads. 

^ It is exceedingly difficult to arrange a classification that will be at once practical 
and scientific, i.e. that wiU show the expenditures of governmental departments as 
they are actually organized, observe the necessary accounting distinctions, and 
answer scientific inquiries of major importance. For American classifications which 
most nearly meet all the requirements, see the financial publications of the Bureau 
of the Census ; the reports of the Comptroller of the State of New York ; the 
Massachusetts reports entitled Statistics of Municipal Finances; and, for the federal 
government, the reports of the President's Commission on Economy and Efficiency, 
and in particular a paper by Harvey S. Chase, C.P.A., deahng with the expenditure 
side of the national budget, in the American Economic Review, Volume v. No. i, 
Supplement, pp. 186-195. A suggestive classification adapted to European condi- 
tions will be found in Cossa's Taxation : Its Principles and Methods, Part ii, Chapter 
iii. The summary census classification printed on the following page covers all 
governmental subdivisions in the United States, except townships and incorporated 
places having less than 2500 inhabitants. 



662 



OUTLINES OF ECONOMICS 



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PUBLIC EXPENDITURES 663 

If access can be had to reports covering a considerable number of years and 
different countries, it will be found that an examination of them will throw an 
immense amount of light upon the nature of modern civilization and its 
direction. 

It is also instructive to compare expenditures on account of the head of the 
State in various countries, and particularly ' to contrast monarchical and 
republican countries. It is important to discover great historical tendencies, 
and to contrast different periods of time, especially as regards monarchical 
expenditures. It is beyond all question that relatively, in the civilized 
world, that is an item of declinirigSijiportance. At the presenlv^ime, the 
king of a great country Hke Prussia or England supports a magnificence of 
state which is altogether out of keeping with the ideas of a defnocracy or a 
repubhc. Four or five millions of dollars per annum for a modern monarch 
is not a large expenditure. On the other hand, in contrast, the expenditures 
of the President of the United States (including those connected with the 
executive mansion, contingent expenses of all sorts, and presidential clerks) 
amount roughly to $150,000. However, as regards the expenditures of a 
modern monarch (the German Emperor, for example), a detailed examina- 
tion shows that custom and tradition, as well as the will of the monarch, 
cause a large part of his income to go for public purposes, and that his wealth 
has been largely socialized. The king is no longer the typical rich man. 

On the other hand, the expenditures on account of the American Congress 
are unprecedented in amount among the expenditures incurred on account 
of legislative bodies. The world has never seen anything of the kind be- 
fore, and nothing parallel to it can be found in any other country. Among 
other things, this goes to indicate, as contrasted vv^ith Germany, the great 
importance of the legislative body which is supposed to represent the people 
directly and immediately and to carry out their will. In aristocratic coun- 
tries the legislative office is sometimes an unpaid office. This was until 
recently the case in British and German parHaments, the idea being to favor 
wealth and to counteract democratic tendencies — an aim which was not 
accompHshed. A democracy, however, is more likely to insist upon a 
legislative office being a paid office; and, in some of the German states, 
although the payment is small, its acceptance is compulsory. 

Expenditures incurred in the administration of foreign affairs are of in- 
creasing importance on account of growing economic internationalism. We 
would here have two main classes ; namely, (i) expenditures on account of 
diplomacy, those representing the purely political side of government, and 
(2) expenditures on account of the consular service, representing the business 
interests of the country. Expenditures connected with boundaries and 
surveys are expenses which would come under this general heading. 

With regard to the administration of foreign affairs, any one nation is 
Hmited in what it can do by international customs. We Americans, for 
example, cannot force our ideas on other nations. Certain standards of 



664 OUTLINES OF ECONOMICS 

dignity and propriety have been established with respect to the mode of hfe 
for diplomats, and, if we depart from these, we do so at a loss which every 
diplomat in the service of the United States keenly feels. The most that we 
can do is to exercise pressure in what we believe to be the right direction, 
and that is the direction of democratic simplicity. 

When we examine expenses incurred in the administration of justice, we 
notice a large increase with the growth of democracy. In earlier times in 
countries like England and Germany, the administration of justice was to a 
greater or less extent "patrimonial," being connected with certain estates. 
The duty of administering justice went with the great estate or manor and 
involved little expense. As people take things into their own hands they 
must pay their own expenses. Democracy, in its progress, means large 
pubhc expenditures. 

The new humanitarianism of the age, which, in a way, is one expression of 
democracy, involves large expenditures, as seen in education, modern re- 
formatories, etc. But it is believed by the advocates of humanitarianism and 
democracy that these expenditures are worth while. 

It is when we come to expenses incurred in the promotion of the general 
welfare that we see the most remarkable and encouraging phenomena that 
greet us in the treatment of public expenditures. This has been seen in the 
data already given, and will become increasingly manifest as the student 
carries on his statistical studies in this field. 

QUESTIONS 

1. Define public finance. Why should it be regarded as a part of eco- 
nomics? Can you give any reasons why it should be regarded as a sepa- 
rate science? 

2. Can we spare money for taxes only when we have an income affording 
a surplus over and above necessities? If the money paid for taxes is used to 
provide us with necessities, is there any good ground for the doctrine that an 
income sufficient to afford a minimum of subsistence should be exempted 
from taxation in the case of an income tax ? 

3. What various meanings do you ascribe to the enormous increase in 
public expenditures during the nineteenth century? 

4. What should be the consequences if the government of the state in 
which you live should strive for the largest possible amount of revenue, and 
then govern its expenditures so as to consume the entire state income? 

5. Discuss the differences between public expenditures and the expendi- 
tures of a private household. Would you regard it wise on your part to 
make any expenditures with the idea that a benefit to some one would accrue 
one hundred years later? fifty years later? twenty years later? 

6. What considerations must govern us when we attempt to answer the 
question, "What is the proper proportion between public expenditures and 
the total income of society?" 



PUBLIC EXPENDITURES 665 

7. Discuss Wagner's rule. Is the fact that public ownership increases 
the permissible proportion of social income that may be used for public 
purposes an argument for pubhc ownership of railways? If so, why? If 
not, why not ? 

8. Discuss economy, parsimony, frugality, extravagance in public ex- 
penditures, and give as full illustrations of each as you are able (a) from your 
own observation, (b) from your reading and conversation and correspondence 
with others, public officials included. 

9. Discuss the historical order in which items of expenditure appear in 
national, state, and local governments. Give illustrations from the state and 
from the local poUtical imit in which you live. Give any illustration which 
may occur to you of taxation which lightens the burdens of the taxpayer. 

10. If you were permanent Secretary of War, would you desire to know for 
a long number of years in advance the yearly sums that could be expended 
on the army ? Could you thus make the same amount of money accomplish 
more than if dependent upon annual grants uncertain in amount? What 
would be your view as a member of Congress? Is a state university to be 
controlled in its expenditures by the legislature as rigidly as Congress should 
control the administration of the army? If so, why? If not, why not? 
Would you make any distinction in this respect between the army and the 
navy? 

11. Present such statistics as you may be able to gather showing relatively 
and for as long a time as possible the increases in public expenditures in the 
federal government, in your own state, and in your own local political unit 
(city, county, town, etc.), and give all the evidence that you can secure show- 
ing the significance of the movement. 

REFERENCES 

Government publications generally. 

As illustrative particularly of the expansion of government expenditures and 
pubhc work, the Year Book of the Department of Agriculture. 

For growth of militarism, take publications of the Department of War and 
publications of similar departments in other countries. 

For general statistical data, the Statesman's Year Book is as reliable as any- 
thing in English. For our own country, see annual Finance Report of 
the Secretary of the Treasury, and census reports, especially the reports 
on Wealth, Debt, and Taxation. For making a broad survey of the federal 
expenditures of the United States, perhaps no single publication is more 
useful than the annual Letter from the Secretary of the Treasury trans- 
mitting Estimates of Appropriations. A striking exhibit of the growth 
of federal expenditures will be found in Senate Document No. 528, 60th 
Congress, ist Session, entitled E.xpenditures of the United States Govern- 
ment, 1791-1907. 



CHAPTER XXXII 

PUBLIC RECEIPTS FROM LOANS AND GOVERNMENT 
OWNERSHIP 

Public Debts. — The modern State follows a policy of deficit 
financiering. The great and increasing expenditures, which 
have been described in the preceding chapter, entail burdens 
too heavy to be borne, at least in the first instance, by taxation 
alone, and recourse must constantly be had to the public credit. 
Even before the European War, about one fourth of the annual 
revenue of England was used in the payment of debt or in- 
terest upon debt ; and, as is shown in the French budgets given 
on page 659, more than one fourth of the total expenditures of 
France was devoted to the same purpose. 

In the last half of the nineteenth century, the aggregate pub- 
lic debt of the civilized world increased enormously. According 
to the best estimates, the indebtedness of the national govern- 
ments of the world, which amounted to $7,627,700,000 in 1848, 
had risen to $27,525,000,000 in 1890, and since that time it has 
greatly increased. Figures showing the total and per capita 
debt of all governmental divisions of this country are given in 
Table I. From this statement it appears that between 1902 
and 1 913 the aggregate public debt of this country increased 
by over $2,000,000,000, the greater part of the increase being 
ascribable to the astonishing growth of municipal and local in- 
debtedness, which increased by 113 per cent in the interval. It 
is true that the total public debt is less than it was in 1870, that 
the per capita debt has fallen from $82.99 ^^ 1870 to $49.97 in 
1 913, and that according to Census estimates of national wealth 
(not very trustworthy), the public debt covered only $2.58 of 
each one hundred dollars of national wealth in 1912, as against 
$2.85 in 1902, $3.06 in 1890, $6.97 in 1880, and $10.64 in 1870. 

666 



PUBLIC RECEIPTS 



667 



But this diminution of the aggregate debt is due to the extraor- 
dinary progress which our tariff surpluses have enabled us to 
make in reducing the debt contracted during the Civil War; 
and the normal movement in the long run is probably toward an 
increase of the public debt, at least absolutely and per capita, 
if not in proportion to the national wealth.^ 

TABLE I 

Public Debt of the United States 
(Debt less sinking fund assets) 





Total in Millions of Dollars 


Per Capita 




1913 


1902 


1890 


1880 


1870 


1913 


1902 


1890 


1880 


1870 


Total .... 
National gov't . 
States .... 
Minor divisions 


$4850 

1029 

346 

3476 


$2839 

969 

239 

1630 


$1989 
852 
211 
926 


$3043 

1919 

275 

849 


$3200 

2331 

353 

S16 


$49.97 

10.59 

3-57 

3S-8i 


$35-99 

12.22 

3-03 

20.74 


$31.76 

13.60 

3.37 

14.79 


$60.66 

38.27 

5.48 

16.91 


$82.99 

60.46 

9.15 

13.38 



The great increase of public debts is due principally to two 
causes, wars and public works. The former are misfortunes, 
losses, however the result is expressed. The loss comes, not in 
contracting a debt, but in spending and destroying the property 
consumed by war. This loss cannot be postponed by a debt, 
although one nation may postpone part of the loss by borrow- 
ing goods and supplies from the people of another nation. It 
comes out of wealth existing or produced at the time, no matter 
what arrangement is made. In former times each man bore 
the loss as it happened to fall on him. The modern method 
differs . in just this, that the loss is transferred to the whole 
public. This, again, may be done in two ways. A tax may 
be levied at the time sufficient to pay all expenses, or a debt may 

1 According to Census estimates, the per capita debt of the United Kingdom in 
1904-1905 was 3.93, that of France 4.86, and that of Italy 2.25 times as great as the 
per capita debt of the United States in 1902, while that of Sweden was a trifle less 
than the per capita debt of the United States. 



668 OUTLINES OF ECONOMICS 

be incurred and the necessary taxation spread over a longer 
period of time. In practice the latter proves far the best, for 
at least a part of the expenses. It gives taxpayers time to 
adjust themselves to the extraordinary demands. A war debt 
is, therefore, not a misfortune, though it stands for a previous 
misfortune — war. 

The case is clearer when we consider debts contracted for 
public works. Under this head we include primarily productive 
enterprises like railways, canals, forests, gas works. These, 
when purchased or constructed by the government, are the occa- 
sion of debts, sometimes enormous in amount. It might seem 
possible to pay for them by immediate and heavy taxation, 
since no more is taken out of the people than when the money is 
borrowed. But the national wealth is not like an ocean, alike 
in all its parts and instantly filling up where water is dipped out. 
It makes all the difference in the world where you dip. Here 
are men who have funds invested in a productive business; 
here are others who have funds lying idle. The State decides 
to make a public investment, and calls for money. If it col- 
lects it by an immediate and heavy tax, the first class have a 
part of their ordinary earnings withdrawn, and their business is 
crippled or ruined. The others have some of their funds with- 
drawn, but the most still lies idle. The best that can be done 
in such a case is for the first class to borrow of the second, 
which only makes private debts instead of public ones — a 
much more burdensome condition of things for the national in- 
dustry. The wiser modern method is for the State to borrow 
the unemployed funds and leave industrial operations intact, 
then imposing a moderate tax which can be paid out of annual 
income. If the expenditure in question is an investment, it pre- 
sumably pays for itself in time without requiring taxation. 

This brings us to the relation between taxes and debts. Taxes 
should never be so heavy that they cannot be paid easily out of 
annual income. If they trench upon national savings, they de- 
range private industries disastrously because they are imposed 
upon all without regard to the nature of their investments. 
But while taxes cannot safely exceed the national disposable 



PUBLIC RECEIPTS 669 

surplus for each year, it does not follow that the State may not 
take savings as well as surplus for its undertakings ; only these 
savings must be taken from those who have uninvested savings. 
This cannot be done by any method of general contribution 
like taxation. It can only be done by public loans. Whether 
the loan is a wise thing or not depends altogether on the nature 
of the State's investment. If the State takes these savings ever 
so wisely and wastes it, the people have lost just so much capi- 
tal. If, on the other hand, the State takes savings which were 
uninvested and therefore unproductive, and invests them in a 
profitable undertaking, the net result to society is an additional 
profit. Public debts are no indication of national poverty. 
Whether a nation is growing poorer or richer depends not on its 
indebtedness, but on its production relatively to its consump- 
tion. Public debts are not a good thing in and of them- 
selves, but they have incidental advantages which offset some 
of their disadvantages. 

Having noticed the natural limits of both taxation and borrow- 
ing, we have now to ask. What kind of expenditures should be 
provided for by each? In general the answer is easy, though 
details are troublesome at times. Ordinary expenditures, that 
is, those which recur with sufficient regularity so that they can 
be foreseen and estimated in advance, if not provided for by 
receipts from d mains and industries, should be met by taxa- 
tion. If the State cannot do this, it is a confession that ordi- 
nary expenditures are in excess of the disposable surplus income 
of the nation, a state of things which means bankruptcy if con- 
tinued long enough. 

Extraordinary expenditures, caused by national calamities, 
such as floods or war, and public investments — railways, 
city gas works, etc. — may be met by loans. The function of 
loans thus becomes a double one : first, the distribution of un- 
avoidable losses, so that industry is as little disturbed as pos- 
sible ; and second, the investment of uninvested capital in 
productive public enterprises. 

In the creation and management of public debt it is pecul- 
iarly necessary to observe the golden mean and avoid both 



670 OUTLINES OF ECONOMICS 

improvidence and unwise restrictions. Obviously, temporary 
deficits resulting from a failure of current revenue to meet cur- 
rent expenses, should not be allowed to accumulate and then 
be funded as a permanent debt. This is a vice of boss-ridden 
government which goes far to explain the rapid growth of Ameri- 
can municipal indebtedness in the last half of the nineteenth 
century. Similarly, in our opinion, debt should not be con- 
tracted in order to erect public schools or other durable improve- 
ments which, although capable of rendering service through a 
long period of years, produce no money revenue and represent 
from the fiscal standpoint continuing liabilities rather than 
durable assets. It must be admitted that authorities differ on 
this point ; but even among those who sanction the contracting 
of debt to pay for durable improvements which are financially 
non-productive, it is agreed that in any event the life of the 
debt should not exceed the life of the improvement in question. 
Long-time bonds, for instance, should not be employed to resur- 
face roads and pay for highway improvements which will last 
only a few years. Finally, in our opinion, restriction may be 
properly imposed upon public indebtedness contracted for pur- 
poses which are fiscally nonproductive, although such restric- 
tions should limit the increase of indebtedness and, for reasons 
which have been stated on page 653, should not be expressed 
as a percentage of the assessed valuation of taxable property. 

On the other hand, few, if any, restrictions should be placed 
upon borrowing for the purpose of acquiring income-yielding 
property. Such restrictions place states and cities at a dis- 
advantage as compared with private corporations. They also 
ope ate to throw into the hands of private corporations enter- 
prises which cannot be paid for out of one year's revenue, and 
yet might advantageously be acquired by the public. At the 
present time excessive limitations, unworthy of a free people, 
make it impossible for some cities to carry out necessary public 
improvements which would not impose the slightest real burden 
upon taxpayers. In Chicago, several years ago, after a pro- 
longed and exceedingly expensive campaign for the improve- 
ment of the street car service, the city was prevented from carry- 



PUBLIC RECEIPTS 6'/! 

ing out a carefully devised plan of reform by a court decision 
which held that an issue of street railway certificates would in- 
crease the indebtedness of the city beyond the limits prescribed 
by the constitution. Rigid limitations which prevent munici- 
palities from offsetting part of their debt by the value of water- 
works, lighting plants, and other assets which yield a monetary 
return, have no place in a scientific system of public finance. 

While not absolutely required by theory, it is probably desir- 
able as a matter of practical political psychology to make pro- 
vision for the extinction of all public debts within a period, say, 
of sixty years. It has been customary in the past to do this 
by means of sinking funds, but experience has shown that the 
sinking fund is a cumbersome, wasteful, and unscientific method 
of accomplishing the desired end. Bonds which automatically 
mature in recurring installments offer a much better device for 
the retirement of public debts. The serial bond, as such an 
obligation is called, " can usually be placed at a lower rate of 
interest than a sinking fund obligation. It is free from most 
of the possibilities of political abuse and manipulation to which 
sinking funds are exposed. It substitutes a plain and certain 
for an uncertain or complicated liability; and it compels the 
administration which contracted the debt to begin its retire- 
ment immediately." ^ 

The Public Domain. — By domains we usually mean agricul- 
tural and mineral land and forests owned by the State and man- 
aged in the interest of the public revenue, although we might 
logically subsume under the term the streets and other public 
property of cities, with all the valuable franchises and privileges 
which go with them. The direct revenue from this source in 
the United States is not large, and if account be taken of the 
cost of the public domain and the expense which it has entailed, 
the net earnings would possibly be a minus quantity. 

Until a comparatively recent date this was not the case. In 
early feudal times the king had large estates of his own from 
the produce of which the government was largely supported, 

1 Report of the Committee on Increase of Public Expenditures, Proceedings oj 
the National Tax Association, vol. ix, p. 465. 



672 OUTLINES OF ECONOMICS 

and although he had certain military rights over his subjects, he 
had very limited rights over their property. Later, the king 
became a public rather than a private person, and a large part of 
the crown estate became the property of the public ; but even 
then taxation was relatively unimportant, and the State relied 
principally in times of peace upon fines, escheats, fees, crown 
prerogatives (certain dues which the king was entitled to col- 
lect as of his own right), and upon the proceeds of the public 
domain. Blackstone, the great English jurist, writing in 1765, 
classified taxation among the " extraordinary " revenues of the 
sovereign ; and in some of the German principalities the govern- 
ment was enabled to get along without taxation in times of 
peace, down to the close of the eighteenth century. Real 
democracy not yet having been achieved, the people distrusted 
taxation and resented its imposition, while the sovereign wisely 
clung to that species of revenue which was independent of the 
people's caprice. " The public domains," said Bodin, the great 
political philosopher of France in the latter part of the sixteenth 
century, " should be holy, sacred, and inalienable either by 
grant or by prescription." 

But as democracy developed and the representatives of the 
people gained control of the finances, a new policy was every- 
where adopted. If State management was uneconomical and 
wasteful, and if the government could obtain all the revenue 
needed by taxation, why preserve the wasteful methods of 
management? Why not turn public property into private 
property, to be developed and multiplied through the vitaliz- 
ing force of individual self-interest ? The great truth was real- 
ized that the property of individuals, when subject to taxation and 
regidation, is no less part of the great patrimony of the State than 
those lands and forests whose title is retained by the government 
itself. This doctrine was generally accepted by the greater 
countries of the world during the eighteenth century, so that 
Adam Smith, in defending it in 1776, was able to write that 
" there is not at present, in Europe, any civilized state of any 
kind which derives the greater part of its public revenue from 
the rent of lands which are the property of the state." This 



PUBLIC RECEIPTS 673 

philosophy was dominant when our national government was 
created in 1789, and has guided our national policy ever since. 
Land Policy of the United States. — By exploration and occu- 
pancy, war, and various cessions, the federal government ac- 
quired, after the Revolutionary War, a magnificent domain of 
2,252,244 square miles. Now, while we have consistently fol- 
lowed the doctrine of alienation until very recent years, trying, 
apparently, to get rid of the public domain as rapidly as possible, 
one observes historically a very important change in the manner 
of development. In the early years of the Republic, large 
revenues were expected from the sale of public lands ; it was 
the financial side which, according to Alexander Hamilton, 
claimed " primary attention." ^ Until about 1800, the policy 
was to sell the land in large blocks, even though it went to 
speculators ; this was followed by an attempt to sell small hold- 
ings to actual 'settlers, the credit system being used with dis- 
astrous results; later (1830), the preemption policy was intro- 
duced by which bona fide home makers were given certain ad- 
vantages in purchase ; and finally came the Homestead Act of 
1862, the Timber Culture Act of 1873 (now repealed), and the 
other less important laws by which actual settlers can obtain 
homes practically free of cost. From the very beginning we 
have used our public lands as bounties, to hasten the develop- 
ment of the country ; and this policy has been carried out by 
enormous grants of land for the endowment of education and 
the subsidization of canal, railway, and other internal improve- 
ment companies. Our original aim, however, was not only to 
develop the country as rapidly as possible, but to secure as much 
revenue as possible from the sale of public lands. We still aim 
to develop the country, but the idea of profit has been replaced 
by the policy of giving land to the landless. To exaggerate the 
evolution of policy for the sake of emphasis, it may be said that 
we began with a productive policy, and modified it with a dis- 
tributive policy; that in the beginning our object was the 
greatest good, while now it is the greatest good to the greatest 
number, or, in terms more appropriate to the exact case in hand, 

> Quoted by Donaldson, The Public Domain, p. ig8. 

2X 



674 OUTLINES OF ECONOMICS 

the greatest possible use of the pubHc domain consistent with 
widespread participation in that use. 

Forest Lands. — The policy of alienation, while on the whole 
sound, is subject to certain limitations which it is very important 
to note. First of these is the case of forests. The ruthless de- 
nudation of our timber lands, the striking advance in the price 
of lumber indicating that the supply has not kept pace with the 
demand, and the meteoric development and rapid decline of the 
lumber industry in many localities of the Northwest, all com- 
bine to demonstrate that ahenation and private ownership have 
failed to produce that careful industrial management which 
conduces to the greatest use and the greatest good in the long 
run. More important still, we have come to realize that the 
most productive use of other great natural resources has not 
been subserved by the private ownership of the forests. The 
regular flow of streams, the success of the great irrigation works 
which we are building, and the proper development of our mines, 
all depend more or less upon the permanent preservation of our 
forests ; but private ownership and management in the past has 
led to destruction, not preservation. 

The United States awoke very slowly to these truths. Prussia 
abandoned the policy of disposing of forest lands in 1831. 
France and Austria began to increase their forest holdings about 
1870. But in the United States it was not until 1876 that an 
awakened interest showed itself in a congressional appropriation 
of two thousand dollars for the purpose of employing " a com- 
petent man to investigate timber conditions in the United 
States." In 1881 a Division of Forestry was created in the De- 
partment of Agriculture. This expanded into the Bureau of 
Forestry in 1901, and into the Forest Service in 1905. In 1891 
a forward step was taken by the passage of an act authorizing 
the President to establish forest reserves; and in the same 
year the first forest reserve was established. In March, 1915, 
the area of the national forest reserves had increased to 
184,611,596 acres (of which 21,337,533 were privately owned) ; 
the forest service had developed to a point where it was able to 
care for the management of this vast national industry, and to 



PUBLIC RECEIPTS 675 

cooperate further with private owners in estabhshing the prin- 
ciples of scientific forestry, while the policy of alienation has been 
modified to an extent amounting almost to reversal. Instead of 
selling forests, the government is now permitting timber to be 
cut in a way to preserve the forests. The revenue from this 
source at the present time is nearly $2,500,000, but that is a 
secondary consideration. The important point is that the 
government has demonstrated its ability to manage the forests 
along lines at once scientific and commercial. In many Euro- 
pean countries, however, a greater revenue is secured from the 
forests. In France, for example, the public forests cover nearly 
18 per cent of the entire land surface of the country, and yield 
approximately, it is reported, $2.50 per acre annually, — giving 
a revenue of about $59,000,000 a year. In the United States 
at present 35 per cent of what is received, according to law, goes 
to the states and territories in which the reserves are situated 
for public roads and schools. It is estimated that in a few 
years the reserves will yield not less than $5,000,000 a year. 

Experience seems to show that the public ownership and 
management of forests is more efficient than private ownership 
and management. This is due to the length of time required to 
realize upon investments in this industry, its routine character, 
the large area one man can supervise, and, perhaps chiefly, to 
the fact that the government in its management takes into ac- 
count the interests of the community as a whole. Although 
private corporations may make plans for a long period of time, 
they are less desirable owners and managers, especially in the 
last particular. The property tax, as now levied, is one of the 
greatest enemies of rational forestry by private owners. If an 
owner is forced to pay ordinary property taxes upon a stand- 
ing or growing forest year after year, the pressure to cut the 
timber is almost irresistible. The State spends millions of dol- 
lars to preserve the forests, and yet often enforces a tax that 
puts a premium upon their destruction. 

Mineral Lands. — Our experience with timber lands is im- 
portant as showing that private ownership of some kinds of 
land has not resulted in the greatest or wisest use of that land. 



676 OUTLINES OF ECONOMICS 

Our experience with mineral lands demonstrates that the policy 
of disposing of public lands in small holdings, free of cost or at 
prices far below their real value, has not led to a widespread 
participation in the use and profit of those lands. The reason 
for this, broadly speaking, is that our policy of alienation in 
small holdings conflicts with the requirements and necessities of 
modern industry. In disposing of our lands we have tried to 
balk the corporation and the speculator in order to subsidize the 
settler and home builder. For instance, we have made the recip- 
ients of homesteads and mineral claims swear that they are not 
acting as agents "/or any person, corporation, or syndicate,'''' or 
" in collusion with any person, corporation, or syndicate, to give 
them the benefit of the land entered," and that the land is not 
being secured " for the purpose of speculation." Yet for pur- 
poses of grazing and in less degree for mining and lumbering, 
modern industrial methods require that large tracts of land 
shall be worked together, and that individual claims shall be 
consolidated. The core of the difficulty was well described 
by Mr. Roosevelt, when President, in these words : " It is a 
scandal to maintain laws which sound well but which make 
fraud the key without which great natural resources must re- 
main closed. The law should give individuals and corporations, 
under proper government regulation and control, the right to 
work bodies of coal lands large enough for protfiable develop- 
ment." And he thereafter recommended laws to authorize the 
leasing, instead of the complete alienation, of coal, oil, and gas 
rights, as well as grazing rights on the public domain. Already 
the royalty has been adopted by some of the state governments, 
and has been employed in a few of the permits issued by the 
federal departments of Agriculture and the Interior.^ In a 
few decades, these leases will probably yield handsome revenues 
in some of the western states which have adopted them. As 
time passes the federal government exercises more freely its 
powers of reserving mineral rights in lands granted to " home- 

1 Cf. the conditions of the interesting permit issued in favor of the International 
Power and Manufacturing Company, and published as Senate Document No. 147, 
63d Cong., I St Sess. 



PUBLIC RECEIPTS 677 

steaders " or municipalities, and of withdrawing from entry 
valuable mineral deposits such as the potash beds of California. 
Year by year, therefore, the policy of complete alienation is 
more and more restricted. 

The Success of our Land Policy. — In a rough, general way, 
our land policy has been a success, as is shown by the unprece- 
dented and almost feverish development of the country in the 
last century, with the creation of a fund of taxable values which 
makes it an easy matter for the state governments to raise all 
the revenue which they need. But in some respects it has 
signally failed. In the first place it has not paid : more money 
has been spent for the purchase, survey, and care of the public 
lands than has been received from their sale and lease. In the 
second place, certain kinds of lands, as we have shown, should 
not have been alienated. And in the third place, our efforts to 
give land to the landless have bred an immense amount of cor- 
ruption, fostered speculation, endowed private monopoly with 
public wealth, and pauperized whole communities. One has 
only to recall the convictions of public officers for land frauds, 
and to read the report of the Public Lands Commission — to 
which specific reference is given at the end of the chapter — to 
appreciate the truth of all these charges. The desert land law 
and the commutation clause of the Homestead Act, they tell 
us, operate far too often " to bring about land monopoly rather 
than to multiply small holdings by actual settlers." ... "In 
many localities, and perhaps in general, a larger proportion of 
the public land is passing into the hands of speculators and cor- 
porations than into those of actual settlers who are making 
homes." ... " Nearly everywhere the large landowner has 
succeeded in monopohzing the best tracts, whether of timber or 
of agricultural land." . . . " Your commission has had inquiries 
made as to how a number of estates, selected haphazard, have 
been acquired. Almost without exception, collusion or evasion 
of the letter and spirit of the land laws was involved." . . . 
" The fundamental fact that characterizes the present situation 
is this : that the number of patents issued is increasing out of 
all proportion to the number of new homes." 



678 OUTLINES OF ECONOMICS 

Possibly the most important lesson to be derived from the his- 
tory of our landed domain is the vital truth that the government 
cannot give away valuable lands or sell them at prices far below 
their real value without subsidizing the speculator, endowing 
monopoly, and pauperizing the people. The poorer classes de- 
rive no real benefit from this indiscriminate public charity. As 
Secretary of the Interior Hitchcock said in 1905, in discussing 
the Timber and Stone Act: ^ " Many transfers of land patented 
under this law are made immediately upon completion of title to 
individuals and companies. In this way a monopoly of the tim- 
ber supplies of the public-land states is being created by sys- 
tematic collusion. ... It has been urged in behalf of this act 
that it enables poor men to enjoy the bounty of the government 
by obtaining tracts of land which they can afterwards sell with 
advantage. A careful study seems, to show, on the contrary, 
that the original entrymen rarely realize more than ordinary 
wages for the time spent in making the entry and completing 
the transfer. The corporations which ultimately secure title 
usually absorb by far the greater part of the profit." When 
Uncle Sam was rich enough — or was supposed to be rich enough 
— to provide us all with a farm, the policy of giving away the 
public domain appeared to be in harmony with the principle of 
equality of opportunity. But when the supply is far below the 
demand, those who receive gifts by lot or similar methods are 
in receipt of special privileges. What once seemed fair has, in 
the course of economic evolution, become unfair and de- 
moralizing. 

Our conclusion may be formulated in the following general 
rule : Only those lands should be wholly alienated whose use 
and development under private ownership lead neither to mo- 
nopoly nor to exhaustion and waste. Or, in more concrete 
terms (remembering that the maxim applies only to those lands 
left to the government, and to the majority of cases, not to every 
specific case), the rule for agricultural lands should be private 
ownership and management, for forest lands State ownership 
and management, for mining and grazing lands State ownership 
1 Report of the Secretary of the Interior, 1905, p. 331. 



PUBLIC RECEIPTS 679 

and private management under a lease or royalty system, by 
which the State shall secure a share of the profits and retain a 
large amount of regulation and control. In disposing of its 
lands the government should endeavor to charge value received, 
as gifts of valuable land, or sales at inelastic schedules of prices 
which place an extreme valuation upon some tracts and an 
utterly inadequate valuation upon others, lead to speculation 
and monopoly, having most of the demoralizing features of a 
public lottery in which the prizes are distributed partly by 
chance and partly in accordance with the cunning, chicanery, 
and unscrupulousness of the participators. Under existing con- 
ditions the poorer classes of society get almost none of the 
valuable lands. Charge value received, and the people, the 
masses, get their share in the revenues flowing to the public 
treasury, in reduced taxes, and more generous expenditures 
for educational, protective, and developmental purposes. 

Land Nationalization and Municipalization. — In recent years 
both state and national legislation have shown a decided trend 
toward the adoption of methods which will yield both greater 
revenue and greater control of those varied forms of national 
wealth which we collectively designate " land." The object of 
this legislation is to prevent monopoly and give to society a 
share in the land values created by social growth. One of the 
most ingenious plans for securing this end ever proposed is the 
single-tax scheme defended with great eloquence and earnestness 
by the late Henry George. His scheme, usually called " the 
single tax," is stated thus in his own words, printed in his organ, 
The Standari: 

" The Standard advocates the abolition of all taxes upon industry and the 
products of industry, and the taking, by taxation upon land values, irrespec- 
tive of improvements, of the annual rental value of all those various forms of 
natural opportunities embraced under the general term 'land.' 

"We hold that to tax labor or its products is to discourage industry. We 
hold that to tax land values to their full amount will render it impossible 
for any man to exact from others a price for the privilege of using those 
bounties of nature in which all living men have an equal right of use ; that 
it will compel every individual controlling natural opportunities to utilize 
them by employment of labor or abandon them to others ; that it will thus 



68o OUTLINES OF ECONOMICS 

provide opportunities of work for all men and secure to each the full reward 
of his labor ; and that as a result involuntary poverty will be abolished, and 
the greed, intemperance, and vice that spring from poverty and the dread of 
poverty will be swept away." 

Mr. George's proposition rests upon an extreme application of 
the doctrines of individualism and natural rights. Man, he 
holds, has an inalienable and equal right to live, and consequently 
an inalienable and equal right to those natural agents which we 
call land, and without which human life cannot exist. This 
right which attaches to the individual cannot be abrogated by 
law or custom, nor can it be alienated by one generation or set 
of law givers. Moreover, it is an equal right. A, B, and C 
each have a right to the soil, but A has no right to better soil 
than B or C ; in consequence of which that part of land values 
which arises from the differential qualities of land belongs to 
society as a whole, and not to particular individuals. But the 
differential value of land expresses itself in the economic rent 
which it yields, and consequently, if society seizes this rent by 
taxation, it will satisfy the demands of the doctrine of natural 
rights, while leaving the actual management and exploitation 
of land in the hands of individual occupiers, thus avoiding the 
perils of direct public management. 

Man also has an unalienable right, Mr. George held, to the 
fruits of his own labor. As the outcome of this right, Mr. 
George concluded that ordinary taxation upon property other 
than land, upon the product of labor as distinguished from land, 
the gift of God, is robbery. In his view it is as immoral to levy 
an ordinary tax as it is criminal to fail to tax that surplus which 
attaches to the better classes of lands, and which we call economic 
rent. 

The policy embodied in Mr. George's scheme differs funda- 
mentally from the policy which we have seen creeping into recent 
legislation. The latter purposes to reserve only a part of the 
value given to some forms of land by social development. Mr. 
George proposes to confiscate all of the " unearned increment." 
Most important of all, the former proposition applies only to the 
future unearned increment, and purposes only to take a part, 



PUBLIC RECEIPTS 68 1 

and that only after fair notice is given. Mr. George proposes to 
take all the unearned increment, past and present, and that 
whether the present owners have been encouraged to believe that 
they might be permitted to appropriate the whole unearned 
increment or not. Herein lies the essential injustice of Mr. 
George's scheme. As a nation we have induced immigrants 
and settlers to take up lands, clear them, and develop them 
with their labor and toil, with the promise that the values thus 
created by themselves and their neighbors should belong to 
them. Their risks and their sacrifices have been great. The 
" unearned increment " is not always unearned. Even if we 
assume that the State made a mistake in pursuing this policy, 
the results of the mistake must be cheerfully borne by the party 
at fault, the State itself. This of course does not mean that 
the private ownership of land is socially harmful, it must never- 
theless be perpetuated. It does mean, however, that if the state 
is to divest private owners, it must in equity compensate them. 

Mr. George not only proposes to confiscate all economic rent 
without compensation, and to abolish all other forms of taxa- 
tion, but the assertion is made in explanation and justification 
of the policy that it will abolish poverty. Such a policy might, 
indeed, prevent landowners, who do not care to use their land, 
from keeping it out of the hands of those who would use it ; but 
how it would effect all the other predicted blessings is difficult 
for most people to comprehend. In the first place, it is difficult 
to imagine how the pure economic rent of agricultural land can 
be separated in practice from the annual value of separable im- 
provements on the land. But apart from this difficulty, the 
appropriation of economic rent by the public without compen- 
sation to the owners will probably never appeal to the conscience 
of the American public as a just thing to do. No abstract 
reasoning, based on " natural rights," will persuade a modern 
nation to so radical a step. This honestly and earnestly advo- 
cated policy is only one more illustration of the danger of basing 
social reasoning on any theory of " natural rights." 

In cities it is easier to separate the pure economic rent from 
the earnings of improvements, such as buildings. Moreover, it 



682 OUTLINES OF ECONOMICS 

is in cities that the principal evils attendant on private land- 
holding are discoverable. Therefore the objections to land 
nationalization do not in the same degree apply to land munici- 
palization. Many who will reject the one will favor the other. 
Even here, however, it is well to proceed very cautiously. Con- 
fiscation, at any rate, should not be tolerated. If great and 
expensive changes along this line should approve themselves to 
the people, the burden of the changes should be widely diffused 
throughout the community by means of inheritance and other 
taxes. ^ 

Public Industries. — In the beginning, let us briefly pass in 
review the principal classes of industrial enterprise in which the 
modern State engages for the satisfaction of other than State 
wants ; because, obviously, we are not concerned with enter- 
prises like the government printing office, the government navy 
yards, and in general, those incidental industries whose products 
the government consumes but does not regularly sell. 

1. First, we find states like Switzerland monopolizing the 
manufacture of alcohol and certain alcoholic beverages, Japan 
monopolizing the opium traffic in Formosa, or commonwealths 
like South Carolina engaging at one time in the retail distribu- 
tion of intoxicating beverages. The purpose of the State in 
engaging in such industries is primarily sumptuary ; it is desired 
to regulate the traffic almost to the point of suppression, per- 
haps. Ordinarily a good revenue would be secured, but revenue 
is a very secondary consideration. Prices will be placed above 
the level of highest net profit, and not improbably the ideal of 
regulating consumption will be so vigorously pursued that profits 
will disappear altogether. 

2. Secondly, we have the group of so-called " fiscal monopo- 
lies." France, for instance, monopolizes the manufacture of 
matches, cigarettes, and tobacco in general ; Japan has recently 
gone farther than any other country in the creation of fiscal 
monopolies ; while Prussia, Austria, Italy, Spain, and other 
European countries maintain public lotteries — as did many of 
the American colonies during the eighteenth century. Tho 

1 See pp. 425 and 706 for further discussion of the single tax. 



PUBLIC RECEIPTS 683 

primary object of the State in undertaking these enterprises is 
public revenue, gain ; and naturally a monopoly price is charged, 
the price which will yield the greatest net revenue. 

3. Next, we have a group of enterprises consisting principally 
of the so-called " natural monopolies," which the State under- 
takes not for suppression, not for profit, but primarily for regu- 
lation — to regulate the quality of the product, as in the case 
of water ; to maintain effectively what have been called " equi- 
table conditions for the prosecution of private business," as in 
the case of railways; to prevent monopolistic extortion and 
corporate abuse, as in the case of lighting companies, the post 
office, the telegraph, and the telephone ; or to prevent crime and 
preserve intact the foundations of commercial prosperity, as in 
the monopoly of coinage. The charges here are ordinarily ad- 
justed to either the " revenue " or the " cost " principle, that 
is to say, the State will either aim to make a fair business profit 
such as is secured in competitive private enterprises, or it will 
endeavor approximately to meet expenses by adjusting its 
charges to the cost of production. England, France, and Ger- 
many, in ordinary years, obtain handsome revenues from their 
respective postal departments, but in the United States the 
accounts of the Post Office Department usually show an annual 
deficit, and taking the world over, the cost principle in this 
group of industries is probably more common than the revenue 
principle, and deficits more common than net profits. In the 
United States the post office has always been regarded as a 
developmental agency rather than a business enterprise, and 
might more logically, perhaps, be included in the next category. 

4. Finally, we have a large and heterogeneous group of in- 
dustries which are maintained principally for service, for their 
educational and developmental influence, not primarily for regu- 
lation, and not at all for profit, but '' for the public good." We 
include here not only schools and educational institutions of all 
kinds, but roads and canals ; the savings banks and public pawn 
shops maintained in several countries of continental Europe ; 
workingmen's insurance as developed by Germany, Austria, 
and several of the Australian commonwealths ; and model manu- 



684 OUTLINES OF ECONOMICS 

facturing establishments such as France maintains for the pro- 
duction of tapestries and fine porcelains. In this group charges 
will sink to a minimum, and in some lines of enterprise, such as 
education, practically disappear. Revenue here is not only a 
minor, but is almost a negligible, consideration. 

A brief consideration of the incomplete list of State industries 
given above brings out several important truths. In the first 
place, it is evident that only a few of these industries, the fiscal 
monopolies, have been taken over by the State for the purpose 
of revenue, and fiscal monopolies are decreasing rather than 
increasing in relative importance. In the second place, it is 
equally as clear that, on the whole, public industries are sources 
of expense and not of profit. When Professor Bastable, for ex- 
ample, tells us that in England, in the fiscal year 1 893-1 894, 
only 6 per cent of the national revenue came from public indus- 
tries and other non-tax sources, that in the local revenues of 
England and Wales (1891-1892) taxation stood to other sources 
of revenue in the ratio of five to one, that in P^^ussia about 20 
per cent of the national revenue comes from the domain and in- 
dustrial enterprises, and in India something less than 50 per 
cent from " quasi-private sources of revenue," he is careful to 
warn us that the statistics take no cognizaiice of interest pay- 
ments chargeable to the several industries, or of depreciation, 
or of related industries in which deficits and not profits were 
secured. When estimating the importance of State railway 
earnings in the revenue account, no cognizance is ordinarily 
taken of the canal deficit. In the third place, we perceive from 
the nature of the industries that they cannot wisely be operated 
for profit in many cases. Education, for instance, has been 
taken over by the State for the very purpose of charging less 
than the cost of the service. The unquestionable tendency is for 
the prices of goods and services supplied by a democratic State 
to sink below the cost of production, and this, in itself, is neither 
good nor bad, fortunate nor unfortunate. The public financier, 
in adjusting the charges, must not look to profit. His only aim 
is the salus populi, and this policy requires here a prohibitive 
price, there a cost price, and again free service. Finally, it 



PUBLIC RECEIPTS 685 

appears, the problem of public charges can be settled only with 
reference to a particular time, place, and industry. England 
finds it expedient to raise a handsome revenue from her post 
office, while in most years the United States manages her post 
office at a loss. Waterworks are successfully conducted by most 
of the large American municipalities, but public lighting experi- 
ments in this country have not been equally successful. India 
raises half of her revenues from non-tax sources largely because 
heavy taxation of the ordinary kind would be impossible. The 
French tobacco monopoly succeeds because the French govern- 
ment can supervise and trace almost every pound of tobacco 
grown in France. In the United States this would be impossible. 

Although we cannot decide in a general way what theory of 
charges should be followed in particular public industries, it is 
possible to lay down general rules which will assist us in reach- 
ing a correct conclusion in specific cases. Assuming that the 
industry in question supplies a service rather than a commodity, 
merely to save words in the discussion, we must first of all in- 
quire : (i) Is the service helpful or harmful in its net social 
effect ? According as it is one or the other, we will incline in 
our charges toward the gratuity principle or the prohibitive 
principle. If harmful, however, it is plain that we must not 
make the charges high enough to encourage smuggling or illicit 
manufacture. If helpful, on the other hand, we cannot at once 
decide upon the gratuity principle, but must inquire further : 
(2) How generally is the service enjoyed ? If only a small portion 
of the community enjoys the service, it would usually be unjust 
to charge less than cost, because the deficit would be borne by 
general taxation falling upon the entire community ; unless, in- 
deed, the benefit to one restricted class is seen to be of advantage 
to the whole community in such a degree that the rest of the 
community is willing to bear the deficit, as in the case of public 
charity. 

(3) Assuming that the service benefits the whole community, 
this is still not sufficient to justify a charge less than the cost of 
production. The problem is one of comparative costs. We 
must inquire whether greater benefit would not be secured by 



686 OUTLINES OF ECONOMICS 

charging enough to raise a profit and then distributing that profit 
through the maintenance of some other gratuitous enterprise, 
or, if the tax system weighs heavily on the poor, by remitting 
taxation to the extent of the profit (4) If all these questions are 
answered in favor of the gratuity principle, we still must con- 
sider what effect gratuitous service will have upon the cost 
of the service. Will it encourage wastefulness? Free city 
water, for example, would probably prove impracticable because 
of waste, but free parks or free education do not lead to inordi- 
nate or unnecessary consumption. The question is a vital one, 
but it is not always to be answered one way, as some critics of 
government ownership seem to believe. (5) Closely related to 
the above is the question of pauperization. Some things the 
State may safely give away, and some not. The modern city, 
for example, may give free band concerts, in, our view, to the 
undoubted edification of the community ; but in Rome the 
public games demoralized the populace. (6) Finally, we have 
to ask what effect gratuitous service will have on incomes. 
Henry George proposed that our cities should operate the street 
car lines gratuitously, and the argument in its favor is far 
stronger than might be expected on first thought. But what 
effect would this gratuitous service have upon the incomes of 
the laboring classes ? Take the case of the worker in New York 
City earning $3.00 a day. Will his wages remain at $3.00, if 
.street car service is offered free of charge? Will not the migra- 
tion to New York be increased, so that wages will fall? And 
may not the gain ultimately fall to owners of house property in 
the form of enhanced rents? 

All these questions must be answered before the tariff of 
charges can be adopted, and it is plain that the answers will be 
determined by the particular conditions of time, industry, and 
place, particularly by the character of the industry. The nearest 
approach to a general rule which can be formulated, may be 
stated as follows : In proportion as a service or commodity tends 
to the upbuilding of character and personality, we should, so far 
as fiscal conditions permit, gradually move in the direction of 
the principle of gratuitous service. If'the service or commodity 



PUBLIC RECEIPTS 687 

itself is widely consumed and is as desirable as any vendible 
commodities which would probably be purchased from possible 
revenues yielded by charges for the service, particularly if large 
consumption is desirable and waste in consumption does not 
become excessive, the principle of gratuitous service may be 
recommended. 

Limitations of space prevent further treatment of the subject 
of public industries. The important thing to understand is that 
the moment an industry is taken over by the government, that 
moment the question of profit — which is the vital considera- 
tion under private management — becomes of secondary im- 
portance, subordinate to questions of public policy; and the 
interjection of public policy into the determination of prices or 
charges, creates a problem whose complexity and difficulty can 
scarcely be exaggerated. At the present time, for instance, we 
do not even know whether our postal rates on second class mail 
matter pay for the cost of carriage and delivery, to say nothing 
of the question whether such matter ought to be carried at less 
than cost. Just now the indications are that the State will 
take over an increasing number of industries, or at least exert a 
constantly increasing influence upon the rates and charges of 
quasi-public industries. Under these circumstances our present 
duty is to institute, both in public and quasi-public industries, 
a thoroughgoing system of cost accounting, so that we shall 
understand upon what footing each branch of the industry rests. 
Our second duty, which falls primarily upon economists and 
statesmen, is to develop a far more satisfactory theory of public 
charges, for at the present time we hardly understand the many 
factors that must be considered in this problem, much less the 
net meaning or resultant of these factors. 

QUESTIONS 

1. Are public debts a burden when represented by paying investments? 
by non-revenue-bearing investments? 

2. Do State debts indicate impoverishment of the people? Why? 

3. What defects are found in the sinking-fund method of retiring public 
debts? Enumerate the advantages of the serial bond. 



688 OUTLINES OF ECONOMICS 

4. How was the State supported in primitive times? What connection 
is there between taxation and representative government? 

5. What has been the principal aim of the United States in the manage- 
ment of public lands ? How has this aim changed ? 

6. Why do the poorer classes benefit least by the homestead acts and by 
the sale of the public lands at prices below their real value? 

7. What kinds of land should be both owned and managed by govern- 
. ment ? Why ? 

8. What are the advantages and disadvantages of the royalty or lease 
system? To what kinds of land should it be applied? 

9. What conflict is there between modern industrial methods and the 
project of giving land to the landless? 

10. What connection is there between "natural right" and the single-tax 
scheme ? 

11. Is there any absolute, inalienable right to life? to anything? Ex- 
plain. 

12. Should State industries be managed so as to yield a profit? Is a 
profit inconsistent with good State management? Is any general tendency, 
with respect to profits, discernible in the management of particular public 
industries ? 

REFERENCES 

Adams, H. C. Public Debts; The Science of Finance, pp. 237-260, 261-282. 

Bastable, C. F. Public Finance, 3d ed., pp. 157-178, 179-218, 219-232. 

Bullock, C. J. Selected Readings in Public Finance, Chap, iv, "The Views 
of Bodin and Smith," pp. 50-60; Chap, v, "Revenues from Domains," 
pp. 61-72; Chap, vi, "Revenues from Public Industries," pp. 80-116. 

Bureau of the Census. Reports on Wealth, Debt, and Taxation, and Statistics 
of Cities. 

CoHN, GusTAV. The Science of Finance (translated by Thorstein Veblen), 
pp. 82-103. 

Daniels, W. M. The Elements of Public Finance, pp. 207-223, 285-314. 

Grice, J. W. National and Local Finance. 

Hewes, L. L, and Glover, J. W. Highway Bonds. (Bulletin of the U.S. 
Department of Agriculture, No. 136.) 

Plehn, C. C. Introduction to Public Finance, 3d ed.. Part iii. 

Raymond, W. L. American and Foreign Investment Bonds, Chaps, ii-v. 

Report of the Public Lands Commission, Senate Document No. 189, 58th Con- 
gress, 3d Session, pp. iii-xxiv. 

Scott, W. A. The Repudiation of State Debts. 

Seligman, E. R. a. "Classification of Public Revenues," in his Essays in 
Taxation, rev. ed., Chap. xiv. 

U.S. Department of Agriculture, Forest Service. The Use Book. 

Van Hise, C. R. The Conservation of National Resotirces in the United States. 



CHAPTER XXXIII 

PUBLIC RECEIPTS FROM FEES, SPECIAL ASSESS- 
MENTS, AND TAXES 

Definitions. — If the reader will run over the classification of 
public industries given in the preceding chapter, he will notice 
that the corresponding payments — which descend, it will be 
remembered, from prohibitive to gratuity charges — fall into 
two main classes : those imposed upon the consumer or pur- 
chaser who specially benefits by the service, and those — like 
the revenues devoted to the maintenance of education and pub- 
lic parks — imposed upon the tax-paying public generally, irre- 
spective of the benefits conferred by the service. Moreover, 
as we move from the prohibitive to the gratuity group, there is 
a general though not regular change in the degree and kind of 
compulsion exercised by the State in collecting the contribution. 
The State does not encourage the purchase of intoxicating liquors 
under the Gothenburg system in order that the revenue may be 
as large as possible, — it actually discourages their sale ; the use 
of the postal money order is mildly encouraged, but you may 
send your money by express if you desire ; one is not forced to 
marry, but if one marries one is compelled to take out a mar- 
riage license ; and whether one uses the public schools or not, 
one must help pay for their maintenance. Finally, it will be 
noticed that as the element of compulsion increases, the public 
interest in the service changes, and generally though not always 
increases. The wood sold from the government forests is 
merely a commercial by-product of an enterprise maintained 
by the government for other purposes ; the marriage-license 
fee benefits the individual, but is imposed primarily to protect 
the morals of the community ; while the tax to maintain the 
public schools is paid solely for the purpose of benefiting the 
general public. 

2Y 689 



690 OUTLINES OF ECONOMICS 

There are, then, three general principles of classification : 
(i) the assignability of the benefit of the service to an individual ; 
(2) the degree of compulsion exercised by the State ; (3) the 
degree and kind of public interest involved in the service. The 
more voluntary payments for the more commercial services made 
by persons who receive a special benefit from these services are 
called public prices ; the less voluntary payments for services in 
which the public interest is less commercial in character, made 
by persons who receive a special benefit from the services, are 
called fees. Compulsory contributions, " levied in proportion 
to the special benefits derived, to defray the cost of a specific 
improvement to property, undertaken in the public interest," 
are, in the United States, called special assessments ; and com- 
pulsory contributions, exacted by public authority according 
to some general rule, without reference to the special benefit 
conferred by the services to whose maintenance the contribu- 
tions are devoted, are called taxes. 

The student is warned that little regard 'is paid to these dis- 
tinctions in everyday usage. The words " fees," " taxes," 
" licenses," " tariffs," " rates," " charges," and the like are 
hopelessly confused ; and even census statisticians find it im- 
possible to distinguish, in public accounts as they are now kept, 
between prices, fees, rentals, licenses, and some kinds of taxes. 
The utility of the terms is in emphasizing the important truth 
that these great categories of public contributions must be dis- 
tinguished and differently treated by the legislator and student, 
by whatever terms the different categories are designated. 

Fees.^ — In the exercise of its most fundamental and general 
functions, the government frequently confers, in an incidental 
way, special benefits upon particular individuals. Thus the 
courts, whose function it is to administer justice in general, find 
that this function must be performed by deciding disputes be- 
tween particular litigants, one of whom usually benefits by the 

' Public prices have been discussed in the preceding chapter. The small tuition 
charges paid by students in state universities offer a good illustration of fees ; they 
are non-commercial in character, semi-voluntary, and in amount fall considerably 
short of the cost of the service. 



PUBLIC RECEIPTS 69 1 

decision. Now if the government is disposed to take advantage 
of the opportunity, it is evident that much revenue may be 
raised from the individuals who, in a more or less adventitious 
way, benefit from the government activities ; and where the 
nation is poor or the people averse to taxation, much dependence 
will be placed upon fees. As wealth increases, however, and 
the government becomes more democratic, there is a growing 
disposition to support general functions by general contributions 
— taxes — and the relative importance of fees is likely to de- 
cline. On the other hand, there is no likelihood that fees will 
wholly disappear, as they exercise a wholesome influence in pre- 
venting waste. Court fees, for instance, would probably have 
been abolished before this, if they did not serve to prevent 
litigious persons from carrying their quarrels to the courts for 
settlements. Because of this restrictive and economical in- 
fluence exercised by fees, they will undoubtedly retain a per- 
manent place in the public revenues of even the more advanced 
and democratic states ; but their fiscal importance will very 
likely decline. 

During the colonial epoch the fee system was much abused in 
America, many offices being wholly maintained by fees which 
should have been abolished or supported by taxation. At the 
present time, however, the evils of the system arise not from 
the number or amount of fees, but from their connection with 
the salaries of certain public officials. Many officials are allowed 
to keep the fees which they collect in lieu of fixed salaries, and 
this practice results in very serious evils. In the first place, 
some fee-paid offices, particularly those of sheriff and register 
of deeds in populous districts, have come to yield princely in- 
comes, and the scramble for these rich offices constitutes a pro- 
lific source of political corruption. In the second place, fee pay- 
ment of public officials often impels them to an excessive and 
pernicious activity, in which their own interests and those of the 
commonwealth are placed in direct conflict. In a few states, 
for instance, prosecuting attorneys are paid so much per con- 
viction, the fee increasing with the heinousness of the offense, 
whUe in many cities and villages the police force and city courts 



692 OUTLINES OF ECONOMICS 

are supported partially by fees and fines. Under these circum- 
stances, officials bend their activity to the conviction of offenders, 
not to the prevention of crime and the reform of the criminal ; 
they frequently set traps for persons who are likely to break the 
law, creating the temptation and the opportunity in order that 
they may increase their emoluments. In Wisconsin, sheriffs 
were for many years paid so much per head for the tramps whom 
they fed and lodged. The system, as has been said, placed a 
" direct premium upon vagrancy." ^ During the existence of 
this system in Wisconsin, tramps were " often furnished with 
liquor, tobacco, and newspapers, to induce them to return." 
Finally, the fee system has been a constant and shameful cor- 
rupter of justice as dispensed by justices of the peace in " the 
people's courts." In most states there are several justice's 
courts open to the plaintiff who desires to bring suit. In con- 
sequence, a disgraceful competition springs up, each justice en- 
deavoring to swell his business and multiply his fees by con- 
stantly finding for the plaintiff, with the result that our judicial 
system is thoroughly vicious at the point where perhaps it comes 
in closest contact with the masses of the people. 

The remedy is in the substitution, wherever possible, of regu- 
lar salaries for fee stipends, and in the institution of methods of 
accounting which will hold public officials to strict accountability 
for every fee collected. Fortunately, the movement of legisla- 
tion, while slow and obstinately fought by some politicians, is in 
the right direction ; and in almost every state public officials 
are being required to turn their fees into the general treasury 
and accept instead a fixed compensation. 

Special Assessments. — Where the operations of the govern- 
ment confer a special benefit upon some restricted group of in- 
dividuals, those individuals are often led to exercise undue in- 
fluence upon the government to secure that service, if the latter 
is supported by appropriations from the general funds. Jobbery 
and graft are encouraged. On the other hand, if the only way 
the group of individuals can secure the service is by expenditure 

1 T. K. Urdahl, The Fee System in the United States, p. 211. The other quotations 
cited in this section are taken from this work. 



PUBLIC RECEIPTS 693 

of the common funds, the government or legislature often delays 
the expenditure unduly for fear of criticism or because of unwise 
parsimony. Thus in cities where the method of special assess- 
ment is not used, it often happens that the opening of a street 
is delayed long after the time when it would be desirable for 
the citizens most interested, although perhaps the latter would 
be willing to defray the cost from their own pockets, were this 
permitted. 

A recognition of these facts has led in recent years to a strik- 
ing development, in the United States, of the benefit principle 
as exemplified in the method of special assessments. The special 
assessment has been used sporadically in many countries for 
several centuries, but it was first regularly used on a wide scale 
in the United States, in the latter half of the nineteenth century. 
Its place and importance among the revenues is shown in the 
table on page 695, from which it appears that special assess- 
ments aggregating over $113,000,000 were collected in 1902. 
This amount constituted a little more than 4 per cent of the 
revenue receipts; but as the national and state governments 
(except Massachusetts) make practically no use of the special 
assessment, its real importance appears more clearly from an 
examination of its place among municipal revenues. In the 
incorporated places having 2500 inhabitants or over in 1913, 
special assessments yielded nearly 9 per cent of the revenues 
and more than one eighth as much revenue as all kinds of taxes. 

The special assessment has been approved by the American 
courts because it places at least a part of the cost of the service 
upon the beneficiaries of the service, a rule which can sometimes, 
but not often, be violated without subjecting the government to 
'excessive and corrupting private influence. The special assess- 
ment has appealed to the people, however, because it permits 
public improvements to go ahead at a pace which would be im- 
possible if taxation were the only fund for defraying the cost of 
the improvements. Needless to say, the special assessment has 
occasionally stimulated extravagance and premature develop- 
ment. Thus, in New Jersey, in the last quarter of the nineteenth 
century, several large cities were practically thrown into bank- 



694 OUTLINES OF ECONOMICS 

ruptcy by undertaking ambitious public works, in which the 
special assessment played an important part. And in New York, 
under the Tweed regime, the system of special assessments fur- 
nished an excuse for undertaking public works in which corrup- 
tion flourished, and which probably would never have been under- 
taken, had it been known in the beginning that their cost would 
have to be partially defrayed by taxation. " The works had 
been carried on upon a scale of audacious extravagance, and in 
portions of the city where they were not at the time justified. 
Great avenues were laid out and improved largely for the pur- 
pose of giving fat jobs to favorite contractors, and to provide 
fine drives for the pleasure and convenience of others than the 
abutting property owners." ^ 

On the whole, however, the special assessment has been an 
unusual success as a fiscal expedient, and has proved an im- 
portant, if not an indispensable, factor in the development of 
American cities. Where its use has been followed by extrava- 
gance, speculation, or jobbery, these evils are to be attributed 
almost wholly to political corruption of the government, and 
only in a very small measure to the special assessment itself. 
Most of the evils, moreover, have arisen where the city govern- 
ment, or some department of the city government like that of 
public works, has been given the power to order the improve- 
ments against the will of the property owners involved or where, 
^s was the case in the example cited above, assessments upon 
particular lots were permitted to exceed the value of the prop- 
erty. Special assessments should not be levied against the will of 
a majority of the property holders subject to assessment, except 
by a two thirds or three fourths vote of the city council, and in 
no case should the assessment exceed a small fraction of the 
value of the property against which the assessment is laid. 
Where these rules are observed, the special assessment is un- 
likely to lead either to premature development or hardship 
upon the property holder. 

Taxes. — In this country more than 70 per cent of all the 
public revenues are obtained from taxes, so the problems of 

1 Victor Rosewater, Special Assessments. 



PUBLIC RECEIPTS 



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696 OUTLINES OF ECONOMICS 

taxation are the most important with which the public financier 
has to deal. These problems are of two varieties ; those deal- 
ing with the nature of taxation in general, and those dealing 
with specific taxes. The remainder of this chapter will be de- 
voted to the general questions. The following chapter will be 
given over to the more specific problems of American taxation. 
Justice in Taxation. — By far the most important lesson which 
the student of fiscal questions has to learn is the supreme neces- 
sity for tolerance and breadth of view. The factors which con- 
dition justice or make for equity in taxation are exceedingly 
numerous ; and the mistake most commonly made by superficial 
thinkers is to seize upon some one element of justice, build a 
philosophy upon that alone, and vigorously condemn every- 
thing that does not harmonize with their petty and bigoted little 
system. No rule less sweeping than that of the general wel- 
fare can serve as a safe guide in public finance. 

1. Some writers go so far as wholly to deny the right of the 
State to take private property by taxation. These writers for- 
get that there is no such thing as absolutely private property. 
As the State determines what shall be private property, so also 
it determines the conditions of its existence, and the most funda- 
mental condition of private property is the obligation to con- 
tribute to the support of the State. The rights of private in- 
dividuals have always been of a more or less limited nature, and 
among the rights reserved by the people in their organic capacity 
will be found, in every civilized state, the right to take a portion 
of the wealth produced for such purposes as the lawmaking 
power may deem fit. 

2. However, the State must exercise this power over private 
property in an equitable manner, or as this maxim is ordinarily 
expressed in the terminology of constitutional law, taxation 
must he equal and uniform. Thus, for example, the constitu- 
tion of West Virginia provides that: " Taxation shall be equal 
and uniform throughout this state, and all property, real and 
personal, shall be taxed in proportion to its value, to be ascer- 
tained as directed by law." Now, if we examine the way in 
which these requirements of equality and uniformity have been 



PUBLIC RECEIPTS 697 

interpreted in the administration of practical justice, we find 
that equahty and uniformity have come to mean b'ttle more 
than this, that taxation shall not be arbitrary, capricious, or 
plainly unreasonable and that within each class of persons or 
objects the burden shall be equal, (i) Everywhere the legisla- 
ture is given a wide latitude in exempting property, so that in- 
stitutions and industries which are regarded as of peculiar value 
to the people may be encouraged by freedom from taxation. 
Almost everywhere, poll taxes which impose an unequal burden 
upon the poor, liquor licenses which impose unequal obligations 
upon those who pay them, inheritance and corporation taxes 
which single out particular classes of society for unusual taxa- 
tion, are sustained by the courts. Justice in taxation, then, 
does not require rigid equality or narrow uniformity of treatment. 
(2) Institutions which are socially harmful may be subject to 
peculiarly drastic and oppressive taxation ; that is to say, jus- 
tice may take into account sumptuary considerations. (3) Old 
taxes, which would not be used if they were not already in- 
trenched in the fiscal and social system, are permitted to endure ; 
justice takes cognizance of the fact that, other things being equal, 
an old tax is a good tax by very reason of its age. (4) Indirect 
taxes which weigh more heavily upon the poor than the rich 
show no signs of disappearing ; that is to say, justice gives due 
weight to the productivity of a tax, its cheapness of collection, and 
convenience of payment, and balances these considerations against 
factors which we are accustomed to regard as more fundamentally 
ethical. (5) Taxes may be employed to suppress state banks 
of issue, protect home manufactures, and in general to accomplish 
political and social ends other than the mere raising of revenue. 
Taxation is seldom the best agent of social or political reform. 
If there is an evil which needs eradication, the best way is to 
suppress it directly, if possible, rather than discourage it a little 
by general taxation. But this does not affect the general proposi- 
tion that where taxation is an effi,cient remedy, or the only remedy, 
justice sanctions its employment. (6) Finally, it is plain that, 
however we strive, nothing better than approximate justice can 
ever be secured in taxation. A system that frankly recognizes 



698 OUTLINES OF ECONOMICS 

this truth and makes for rough justice, by the imposition of taxes 
which are simple, stable, convenient, inexpensive, and produc- 
tive, is far better than one which attempts to secure exact jus- 
tice through complex and delicate schemes of taxation which 
cannot be definitely or efficiently administered. 

3. The theory of justice most widely accepted by American 
courts at the present time is expressed in the maxim that taxes 
should be proportioned to benefits derived. Like other rules of 
justice, this maxim contains elements of truth and elements of 
error. It is a fairly helpful guide, for instance, in dealing with 
public revenues other than taxes. Public prices, fees, and 
special assessments should, as we have seen, be proportioned to 
benefits, unless there is strong reason for departing from the rule. 
And in the apportionment of taxation among districts or govern- 
mental sections, the rule still retains, and probably always will 
retain, a large measure of validity. Taxation, we say, must per- 
tain to the district taxed, meaning by this that under ordinary 
circumstances it is not wise to tax District A for the benefit of 
District B ; although there are important exceptions to this 
rule. But in the apportionment of taxes among the individuals 
of a given district, the rule has little or no place. This conclu- 
sion follows, if for no other reason, from our definition of the 
word " taxes," which we confine to contributions levied with- 
out reference to special benefits received, either because no 
special benefit can be assigned, or because (as in the case of 
free schools) we specifically desire to lift the cost of the service 
from the shoulders of some of those who specially benefit by the 
service. Moreover, in general, it is impracticable to determine 
what proportion of the general benefits of government accrue to 
particular individuals. 

4. At the present time a great majority of economists agree 
that taxes should be apportioned according to " faculty " or 
ability to pay. It must be confessed that the rule is not very 
satisfactory. No simple measure of ability exists, and many 
taxes, which under a superficial examination seem to conform 
to the rule, such as the general property or income tax, are found 
upon closer examination to violate the rule in many ways. 



PUBLIC RECEIPTS 699 

Despite all these defects, however, the ability principle has ele- 
ments of great strength. It satisfies our sense of justice, in the 
first place, when explicit reasons cannot be given for departing 
from a general rule; and it expresses the ideal towards which 
we strive in voluntary contributions to the church or other 
voluntary joint enterprises of a social nature. In the second 
place, we can frequently ascertain with certainty that the rule 
is being violated, when we cannot define its meaning positively, 
and hence it is capable of practical application in a negative 
way. We may therefore accept the rule in this sense, that un- 
less other treatment is justified by the considerations cited in 
paragraph 2, above, or by analogous reasons, no tax which is 
plainly disproportional to the ability of the contributors should 
be employed. 

5. Accepting the ability principle as the best rule for general 
taxes as distinguished from the specific taxes noted in para- 
graph 2, we at once encounter the difficult question, how is ability 
to be measured? Different writers have recommended as the 
basis or measure of ability, income, outgo or consumption, and 
property. A little cons'deration will convince the reader that 
each of these measures is marked by minor defects. The con- 
sumption of the poor, for instance, is out of all proportion to their 
ability to bear the burdens of the state. Property, on the other 
hand, differs widely in its productiveness, and, moreover, many 
persons with a little property have large incomxcs, and therefore 
great ability to bear taxation. Incomes, similarly, differ in per- 
manence and security, and equal incomes are called upon to 
support very unequal numbers of persons. Fortunately, it is 
not imperative in practice to make a decision between these 
measures of ability. The necessities of fiscal administration 
make it imperative in actual practice to employ all three bases 
of taxation. Property, consumption, and income are all em- 
ployed in the United States at the present time and will un- 
questionably continue to be employed for many generations. 

Progressive Taxation. — After we adopt any concrete measure 
of ability, we soon realize that it is only approximately correct, 
because we are immediately confronted with the question : 



700 OUTUNES OF ECONOMICS 

Does ability increase in direct proportion or more rapidly than 
our measure of ability ; in other words, shall taxes be laid in 
direct proportion to income, property, etc, or shall the rate be 
increased as the amount of income or property increases ? The 
first method is called proportional taxation, the second progres- 
sive . or graduated. If the rate diminishes as the income or 
property increases, we speak of it as regressive taxation; and 
if the rate increases faster than the income or property, but 
toward a fixed limit which it can never exceed, it is referred to as 
degressive taxation. The last kind of rating is of course a special 
variety of progressive taxation, and usually results from the 
combination of a nominally proportional rate with the exemp- 
tion of a fixed sum from all incomes or assessed wealth. The 
American property tax is in principle a degressive tax, though 
it is regressive in practical effect. 

From the theoretical standpoint our real knowledge upon this 
subject is exceedingly unsatisfactory. On the whole, the argu- 
ments of those who approve progressive taxation are more con- 
vincing than those of its opponents, and a majority of economists 
at the present time agree in asserting that ability increases faster 
than income, property, or any common measure of ability. If 
we construe ability as ability to bear sacrifice (as John Stuart 
Mill and some other authorities do) and confine our attention 
solely to the consumer, there can be no doubt that progressive 
taxation is the means by which the least sacrifice will be visited 
upon the community as a whole.^ This is a strong argument, 
because one of the chief immediate effects of taxation is to de- 
prive persons of the necessaries, conveniences, and luxuries of 
life, while the maxim of the greatest good to the greatest number 
— or as it works out in taxation, the least sacrifixe to the least 
number — is one of the most widely accepted rules of social 
conduct. Surveying the ability theory from the positive stand- 
point of ability to acquire or produce property, we find the testi- 
mony almost universal, that as the fortune or income increases, 
the ability to earn or produce more increases at an accelerating 
pace. " It is the first thousand that counts," in the language 

1 See T. N. Carver, Essays in Social Justice, pp. 401-406. 



PUBLIC RECEIPTS 701 

of the successful man who is teUing the younger generation how 
he succeeded. 

Coming to the more concrete and more practical arguments, 
we find that the balance of opinion also inclines to the side of 
those who favor progressive taxation. Let us briefly recapitu- 
late these arguments and attempt to estimate their net resultant. 
Those who oppose progressive taxation charge that the proposal 
is socialistic, that it would discourage the accumulation of 
wealth, that it would not be particularly productive, — mean- 
ing by this that the element of progressivity adds little to what 
would be produced by a proportional rate, — that it would 
stimulate fraud and evasion, that it would interfere with the 
device known as " collection at the source," and that finally 
the whole principle is arbitrary and capricious in the sense that 
there is no natural limit to the increase of the rate. 

To these charges the defendants of progressive taxation pre- 
sent plans ^ by which collection at the source and progressive 
rating may be successfully combined in the same system ; and 
reply, further, that terms are immaterial and questions cannot 
be settled by bandying epithets such as " socialistic," " an- 
archistic," and the like ; that every tax discourages the accu- 
mulation of wealth ; that whether the tax will be productive or 
not, it will relieve the poorer classes to the extent that the pro- 
gressive rates do actually fall upon the rich ; that persons ca- 
pable of evading their obligations to the government will attempt 
to evade proportional taxes as well as progressive taxes ; and 
that all taxation is more or less arbitrary, resting upon the judg- 
ment and common sense of the legislature. The exemptions 
made in every tax law, the size of a license fee of any kind, the 
rates of excise and customs duties, are all " arbitrary " and un- 
limited in the sense that progressive taxation is arbitrary and 
unlimited. Finally, the defendant of progressive taxation 
points out that, owing to the great prominence of indirect taxes 
in our revenue system and the tendency of assessors to assess 
large properties at a lower proportion of real value than smaller 

1 Report from the Select [British] Committee on Income Tax, igo6, pp. iii-vii. Com- 
pare also the provisions of the federal income tax. 



702 . OUTLINES OF ECONOMICS 

properties, American taxation today is in practice regressive, 
and some progressivity is needed, if only to balance the ad- 
mitted regressivity of existing taxes. 

While general considerations thus seem to warrant persistent 
effort to introduce a moderate measure of progressivity into 
our direct taxes, the student is warned that this should not be 
done in any doctrinaire or offhand fashion. A thousand con- 
siderations of practical expediency must be taken into account 
in the shaping of a revenue system, and in the end we are more 
likely to attain the goal which the advocates of progressive taxa- 
tion seek by careful exemptions from taxation, by special taxes 
upon corporations, monopolies, inheritances, and certain forms 
of income, and by directing expenditures to the succor of the weak 
and the equalization of opportunity, than by exclusive depend- 
ence upon any one far-reaching tax such as a progressive in- 
come or property tax. ' . ' 

No tax system, then, can be fairly judged without reference 
to the character of expenditures. Where the expenditures are 
wasteful, corrupt, and unwise, heavy taxation is a curse, — al- 
though even here the rational method of reform is rather to 
root out the corruption and improve the administration, than 
to reduce taxation, even if temporarily it may be wise to do 
the latter. But where the expenditures are on the whole 
wisely and beneficently made, heavy taxation is not an evil. 
No country was ever yet ruined by large expenditures of money 
by the public and for the public. The true principle to be ob- 
served in levying taxes was tersely expressed in the 41st section of 
the constitution adopted by Pennsylvania in 1776 : '' No public 
tax, custom, or contribution shall be imposed upon, or paid by, 
the people of this state, except by a law for that purpose ; and 
before any law be made for raising it, the purpose for which 
any tax is to be raised ought to appear clearly to the legislature 
to be of more service to the community than the money would 
be if not collected, which being well observed, taxes can never 
be burthens." 

Direct and Indirect Taxes. — The considerations just adduced 
have an important bearing upon a problem which will probably 



PUBLIC RECEIPTS 703 

become acute in the near future : the question of raising addi- 
tional revenue by indirect taxation. Indirect taxes have been 
strongly condemned by many authorities in the past, largely 
because they weigh more heavily upon the poor than the rich. 
But if we are to finance successfully a double program of mili- 
tary preparedness and social insurance in the future, it will 
probably be necessary not only to keep most of the indirect 
taxes which we now have, but to adopt others. There are prac- 
tical limits to direct taxation in every country. Pushed be- 
yond a certain point, direct taxes discourage both saving and 
business enterprise. Many of them — although the income tax 
is a marked exception — fall upon the taxpayer in lean years 
as well as in prosperous years, and must be paid even though the 
money to pay them has to be borrowed by the taxpayer. In- 
direct taxes, on the other hand, are usually paid in small driblets 
and there is, in their payment, a voluntary element which makes 
them easier to bear. The person who elects to drink beer may 
pay proportionally a large indirect tax, but he is not compelled 
to drink beer. Moreover, indirect taxes may be levied upon 
articles of luxury and other commodities consumed predomi- 
nantly by the wealthier classes, so as to operate as progressive 
rather than regressive taxes, when considered from a broad 
social standpoint. Finally, even regressive taxes may be 
helpful to the poorer classes if public expenditures are directed in 
sufficient volume to the support of education, social insurance, and 
the equalization of opportunity. It is more important that expend- 
itures should be progressive in their social incidence than it is to 
collect taxes in accordance with schedules of progressive rates. 

The Shifting of Taxes. — Up to this point we have been speak- 
ing as if a tax must remain where it is originally placed. This 
we know is not always the case. Excise taxes, for instance, are 
usually levied with the expectation that they will be passed or 
shifted from the business man, who first pays them, to the con- 
sumer or some other person. The conditions which control the 
shifting of taxes must evidently be considered — at least in a 
very general way — before we discuss the practical working of 
the American system of taxations. 



704 OUTLINES OF ECONOMICS 

The word " shifting " usually refers to the increase of price 
by which the original payer of the tax attempts to recoup him- 
self. This increase of price is usually accompanied by collateral 
economic disturbances or dislocations — suggested by the phrase 
" repercussion of taxes " which is frequently employed in this 
connection — that are quite as important as the mere change in 
price. For instance, an excise tax (per unit of product) upon a 
monopoly may raise the price by as much or even more than 
the tax itself. But the monopolist nevertheless feels the burden 
of the tax in reduced profits. When we say that a tax is shifted, 
then, we do not imply that the original payer evades all the 
evil effects of the tax. 

Mobility is the chief factor which controls shifting ; and this 
in turn is largely dependent upon the inclusiveness or scope of 
the tax, and upon the existence of monopoly or differential ad- 
vantages. Place a tax upon a person or thing which can easily 
move to a jurisdiction where such taxes are not imposed, and 
the tax is very likely to be shifted. Local taxes upon mortgage 
loans offer a good example. Such taxes are very likely to raise 
the interest rate by as much or a little more than the tax rate, 
the " little more " being explained by the trouble imposed upon 
the lender in looking after the tax and the risk that the tax rate 
will be increased. On the other hand, if mortgage lenders are 
constrained by ignorance or custom or the existence of particu- 
larly high rates in this district to keep on supplying the old 
amounts of loans, the tax will not be shifted. Unless the supply 
can be or is reduced by the tax, shifting will not ordinarily take 
place. 

Naturally, theirefore, the particiilar nature of the supply is of 
prime importance. We may illustrate by an excise tax per unit 
of product upon competitive industries of various kinds. In 
industries subject to the law of constant expense, a fixed tax per 
unit of product will raise the price by just the amount of the tax, 
in theory. In industries subject to the law of increasing expense, 
however, the reduction of the supply caused by the tax some- 
what reduces the expenses of production per unit exclusive of 
the tax, and on this account prices in such industries will in- 



PUBLIC RECEIPTS 705 

crease by an amount less than the tax. In industries subject to 
the law of diminishing expense, on the other hand, the price will 
be raised by an amount equal to the tax, plus an amount equal 
to the increased expense of production caused by the limitation 
of supply. 

Mobility, as has been said, is the most important factor in this 
connection, and it may be restricted or destroyed in a variety 
of ways. Monopoly limits mobility, and, as we have already 
seen,^ the monopolist cannot shift a fixed tax or a proportional 
tax on net profits unless the tax is so high as to reduce monopoly 
profits below the amount that could be earned on the same in- 
vestment in a competitive industry. For somewhat similar, 
but not exactly the same reasons, differential gains from durable 
property are peculiarly susceptible to taxation. Thus, econo- 
mists generally indorse the proposition that a tax on economic 
rent falls upon the landlord and cannot be shifted. The validity 
of this depends both upon the durability of land and the fact 
that the tax is levied upon a differential element. If land wore 
out and had to be replenished, the tax would reduce the future 
supply of land and hence raise its price and its rent in the future. 
Similarly, if the tax were levied upon the product of marginal or 
no-rent land, it would elevate the margin, reduce the supply of 
those products or services which land affords, and in this way 
again raise prices and partially reimburse the landlord. But, 
by hypothesis, neither of these suppositions is true. Land, 
as we define it, does not wear out ; and at the margin land yields 
no economic rent. 

The proposition that a tax on economic rent cannot be shifted 
is true, moreover, only of a proportional tax. A tax of so much 
per bushel or pound upon agricultural prbduce would mo'^^e the 
margin of cultivation and thus affect prices. Indeed, the exact 
form of a tax — whether fixed, proportional, or progressive, upon 
net or gross returns, upon product or upon profit — is of funda- 
mental importance always. Generally speaking, proportional 
taxes upon net income are less easily shifted than other forms of 
taxes. 

1 Pp. 202, 203. 



7o6 OUTLINES OF ECONOMICS 

If the object of taxation be durable and the tax a special or 
exclusive one, the price of the object is likely to be reduced by 
an amount equal to the capitalized value of the tax. Prospec- 
tive purchasers of land take into account the taxes that are likely 
to be levied upon it, capitalize these, and subtract their capital- 
ized value from the amount which they would pay for the 
property if it were not liable to taxation. The apparent result 
of this capitalization or amortization of taxes, as the process is 
called, is to place the burden of an endless succession of taxes 
upon the original owner, and relieve subsequent purchasers of 
any real burden. 

Many present-day followers of Henry George find in this prin- 
ciple of amortization at once a justification and a method of 
securing for society all economic rent. Under present condi- 
tions, they say, a man who buys land wholly escapes taxation 
upon it. Consequently, in order to make landowners pay as 
much as other people we should have to increase the tax upon 
land by a rate equal to that paid by the average tax-payer as 
often — say every thirty years — as the land of the community 
changes holders. In this way the State could gradually and with 
justice absorb all economic rent.^ 

But this whole chain of reasoning is fallacious for three 
reasons : (i) What the prospective purchaser capitalizes and 
deducts is not the entire tax on the land, but the excess of that 
tax over similar taxes upon other investments open to him. A 
new purchaser of land does not " buy free of taxes," as is so 
often stated; what he does is to buy free of any excessive or 
abnormal tax burden. After the purchase he not only pays 
taxes in appearance, but in actual fact pays the average tax 
rate.~ (2) In so far as this program of the single taxers was 
anticipated and understood, it would visit the whole burden of 
the '' reform " upon present owners, instead of being distributed 
over several generations. Subsequent purchasers would dis- 
count these periodic increases of the tax and pay to owners for 
their land only the present value of the rapidly vanishing income 

1 See the paper upon "The Single Tax" by C. B. Fillebrown in State and Local 
Taxation (Proceedings of the National Tax Association), vol. i, pp. 286-203. 



PUBLIC RECEIPTS 707 

from land. Land would be valued as a terminable annuity. 
(3) This whole doctrine overlooks the inevitable consequence 
that, if " the selling value of land is an untaxed value " and 
if " the burden of a land tax cannot be made to survive a change 
of ownership," these facts would so increase the demand for 
land that the profits from its purchase and ownership would 
not exceed profits in other lines of investment. Given plenty 
of time, active competition, together with a knowledge of the 
facts of the situation, and such inequalities of taxation are in- 
evitably smoothed out by the natural movement of capital 
toward the taxless field or away from the field in which burdens 
are particularly severe. 

This inevitable reckoning of taxation among the disad- 
vantages of industry brings it to pass that many old taxes are 
diffused over the entire community. Such diffusion does not take 
place when the nature of the supply prevents it from varying 
in nice correspondence with the prospects of profit. A poll tax 
upon laborers, for instance, will in our opinion not be shifted, as 
it is likely to lower their standard of living, stimulate the birth 
rate, and in turn (other things being equal) actually reduce 
wages. But exclusive taxes on capital and business will be 
diffused ; and for this reason there is a profound practical truth 
in the famous dictum of Canard that " every old tax is good ; 
every new tax is bad," when sympathetically interpreted. Of 
course this doctrine assumes that industrial changes are infre- 
quent. The tax system must and should vary with changes in 
the fortunes of business enterprise. The development of a new 
industry making unusual and unexpected profits oft'ers a good 
opportunity of relieving an old industry that has unexpectedly 
fallen upon evil days. And for this reason it is highly desirable 
that state constitutions prescribing a rigidly uniform system of 
taxation should be amended so as to permit reasonable classifica- 
tion of property and business for purposes of taxation. All these 
qualifications of the diffusion theory are true and important. 
But the fact still remains that under ordinary conditions noth- 
ing is worse in a tax system than uncertainty, continual tinker- 
ing with rates, and capricious readjustment of methods. 



708 OUTLINES OF ECONOMICS 

QUESTIONS AND EXERCISES 

1. In accordance with what principles of classification do we distinguish 
fees, special assessments, and taxes? 

2. Enumerate six fees commonly employed by state governments. 

3. What accounts for the rapid development of the special assessment in 
the last fifty years ? Is it possible to apportion the benefits of a pubhc im- 
provement with any degree of accuracy? 

4. Why are liquor licenses distinguished from other licenses and permits ? 

5. Has the state a greater right to tax land and natural agents than 
produced wealth ? 

6. May monopolies be equitably subjected to special taxation? Even 
if the monopoly rests upon superior efiiciency, or upon patent rights justly 
acquired ? 

7. Is rigid equality of taxation a primary and fundamental desideratum? 
Is it possible of achievement? Is there any real distinction between the 
so-called ethical qualities (of equality, uniformity, etc.) and the so-called ad- 
ministrative qualities (convenience, elasticity, productivity, etc.) of a tax? 

8. Is the benefit principle wrong or merely impossible of application? 
If wrong, why do we retain it in fees and special assessments ? 

9. Is it easier to measure ability than benefits? 

10. Is progressive taxation arbitrary? Can it be satisfactorily con- 
sidered apart from the effect of public expenditures ? 

1 1 . Work out the effect of an excise tax on a monopoly subject to the law 
of increasing expense. 

12. Do people buy land " free of taxes " ? If so, why does not everyone 
buy land in order to escape taxation ? 

13. Can our state legislatures be trusted to "classify" property for taxa- 
tion fairly and impartially? State the arguments for and against repealing 
the uniformity provisions common in state constitutions. 

REFERENCES 

Bastable, C. F. Public Finance, Book iii, Chaps, iii, v, and vii. 

Carver, T. N. Essays in Social Justice, Chap. xvii. 

CooLEY, T. M. A Treatise on the Law of Taxation (3d ed.). Chaps, ii and vi. 

Ely, R. T. Taxation in American States and Cities, Part i. Chap. iii. 

FiLLEBROWN, C. B. Taxation. 

Gray, J. M. Limitation of Taxing Power on Public Indebtedness, pp. 25-54, 

642-915. 
Jones, Robert. The Nature and First Principles of Taxation. 
JuDSON, F. N. a Treatise on the Power of Taxation. 
Lyon, Hastings. Principles of Taxation. 
National Tax Association. Proceedings of the National Conferences (formerly 

State and Local Taxation). 



PUBLIC RECEIPTS 709 

Patterson, E. M. (editor), "Readjustments in Taxation," Annals of the 

American Academy of Political and Social Science, Vol. Iviii. 
Plehn, C. C. Government Finance in the United States. 
Post, L. F. The Taxation of Land Values. 
RosEWATER,ViCTOR, "Special Assessments : a Study in Municipal Finance," 

Columbia University Studies in History, Economics, and Public Law, 

Vol. ii. No. 3. 
Seligman, E. R. a. The Shifting and Incidence of Taxation, Part ii, Chap, i ; 

Progressive Taxation in Theory and Practice, Part ii. Chap, iv, and 

Part iii. 
Urdahl, T. K. "The Fee System in the United States," Transactions of 

the Wisconsin Academy of Science, Arts, and Letters, Vol. xii. Part i, pp. 

49-67, 210-230. 
Weston, S. F. "Principles of Justice in Taxation," Columbia University 

Studies in History, Economics, and Public Law, Vol. xvii, No. 2. 



CHAPTER XXXIV 
FEDERAL, STATE, AND LOCAL TAXES 

Federal Taxation 

Constitutional Limitations. — The fundamental character of 
the American revenue system is determined by those clauses of 
the federal constitution which provide that " direct taxes shall 
be apportioned among the several states . . . according to their 
respective numbers " ; that " all duties, imposts, and excises 
shall be uniform throughout the United States " ; and that " no 
state shall, without the consent of Congress, levy any imposts or 
duties on imports or exports, except what may be absolutely 
necessary for executing its inspection laws." 

Just what the words duties, imposts, excises, direct and in- 
direct taxes signify, as used in the constitution, has been a matter 
of considerable discussion. Ordinarily the. word duty "means 
an indirect tax imposed upon the importation, exportation, or 
consumption of goods," being given " a broader meaning than 
custom, which is a duty imposed upon imports or exports," while 
" the term impost also signifies any tax, tribute, or duty, but it 
seldom applied to any but indirect taxes. An excise duty is an 
inland impost levied upon articles of manufacture or sale, and 
also upon licenses to pursue certain trades or to deal in certain 
commodities." 

All these differences turn largely upon the meaning of the 
words direct and indirect taxes. According to most economists 
direct taxes are taxes levied by the state upon those who are 
expected to bear their burden, while indirect taxes are supposed 
to be shifted to others. In the economic sense, therefore, poll 
taxes, property, income, and inheritance taxes are usually 
called direct, while customs taxes and excise taxes are called 

710 



FEDERAL, STATE, AND LOCAL TAXES 71 1 

indirect. It is plain that the economic meaning of these words 
is exceedingly vague, because it is made to turn upon expecta- 
tions concerning the shifting of taxes, and upon few subjects 
is there more uncertainty than upon this. Economists have 
generally protested against any employment of these terms in 
scientific analysis, and where, because of their frequent em- 
ployment both in popular discussion and statute law, it has 
been necessary to retain them, they have tried to introduce a 
more consistent usage. 

Owing to the practical impossibility of maintaining a logical 
distinction between direct and indirect taxes based upon eco- 
nomic principles, it was commonly thought until the latter part 
of the nineteenth century that it was necessary to give these 
terms a strictly historical interpretation, based upon usage cur- 
rent in this country at the time the constitution was adopted. 
Accordingly, capitation and land taxes were generally believed 
to be the only forms of direct taxes. This belief was partly due 
to the fact that the federal Supreme Court at various times 
had sanctioned the use by the federal government of income, 
inheritance, and specific property or consumption taxes. 

In the famous Pollock ^ case, however, the Supreme Court 
rendered a decision in 1895 which was generally interpreted to 
hold that income taxes, so far as they include income from real 
estate and some other forms of property, are direct taxes. 
Nevertheless, what was practically an income tax upon cor- 
porations was adopted in 1909. It was justified by the Supreme 
Court as an excise tax, but the principal difference between this 
excise tax and an income tax proper appears to have been the 
fact that, instead of being levied upon or on income, it was levied 
and assessed " with respect to " or in accordance with income.^ 

^Pollock V. Farmers^ Loan and Trust Co., 157 U. S. 420; 158 U. S. 601. 

* At a later date (January 24, 1916) in the case of Brushaber vs. Union Pacific 
Railroad Company, the Supreme Court upheld the constitutionality of the present 
federal income tax law and Chief Justice White took occasion to expound the tangled 
meaning of the famous Pollock decision. He announced that "the conclusion 
reached in the Pollock case did not in any degree involve holding that income taxes 
generically and necessarily came within the class of direct taxes on property, but, on 
the contrary, recognized the fact that taxation on income was in its nature an 



712 OUTLINES OF ECONOMICS 

Finally in 191 2 the sixteenth amendment to the federal con- 
stitution was ratified, which provides : " The Congress shall 
have power to lay and collect taxes on incomes, from whatever 
source derived, without apportionment among the several 
states, and without regard to any census or enumeration." 

The troublous history of the federal income tax has been 
briefly traced because it illustrates clearly the conditions under 
which the American people must frame and administer tax laws. 
Income taxes were introduced during the Civil War and millions 
of revenue collected under them before their repeal in the early 
seventies. When revived in 1894 the income tax was invali- 
dated by the Supreme Court in a decision which had momentous 
political consequences. The adverse decision was then, by a 
play of words, evaded in the corporation excise tax ; and later 
the entire principle was legitimatized by the sixteenth amend- 
ment. Finally, the Supreme Court decided that the income 
tax is not a direct tax, but under certain circumstances acts 
substantially like a direct tax. Nothing could illustrate more 
clearly the metaphysical complexities introduced into tax legis- 
lation by constitutional limitations whose final interpretation 
rests not with the legislature but the courts. Much may be 
said for the necessity of such constitutional restrictions under 
the American form of government, but none can deny the enor- 
mous difficulties which they throw in the way of consistent, 
simple, and wise tax legislation. 

Use of Direct Taxes by the Federal Government. — Until 
the twentieth century, the constitutional limitations which we 
have been discussing served to concentrate federal taxation 
almost wholly upon consumption, since direct taxes when appor- 
tioned according to population have shown themselves to be 
unjust, unproductive, and exceedingly difficult of collection. 
Congress has made use of direct taxes only five times during the 
history of the national government. Two million dollars was 
apportioned in 1798; $3,000,000 in 1813 ; $6,000,000 in 1815; 

excise . . ." and was invalid only because it acted enough like a direct tax in prac- 
tical effect to be subject to the requirement of apportionment according to 
population. 



FEDERAL, STATE, AND LOCAL TAXES 713 

$3,000,000 in 1816; and $20,000,000 in 1861. Except in the 
tax of 1798, Congress has always permitted any state to assume 
its quota and raise the money as it saw fit, although provision 
was always made for its collection by federal officers, in case 
the quota was not assumed by the state government. It would 
be difficult to exaggerate the unsatisfactory character of such 
taxation. In no case has the federal government ever collected 
the full amount of the tax. The taxes levied in 1814-1816 con- 
tinued to be collected until 1839. The last payments on the 
direct tax of 1861 were not received until 1888; and in 1891 a 
law was passed abolishing further collections and authorizing 
the amounts which had been collected under the act of 1861 to 
be returned. Considerable scandal arose out of this refunding 
act, owing to the enormous commissions paid to certain lobbyists 
for their work at Washington in securing the passage of the law. 
Until the adoption of the sixteenth amendment, therefore, the 
federal government relied almost exclusively, in ordinary years, 
upon customs duties, excises, and similar taxes. 

Customs Duties. — Among federal revenues, customs duties 
held the place of first importance until very recently. From the 
foundation of the federal government in 1789 until the Civil 
War, with the exception of a few excise taxes collected between 
1 79 1 and 1802, the federal government derived nearly all its 
permanent regular revenues from customs taxation, and since 
the Civil War considerably more than 50 per cent of the per- 
manent revenue has, on the average, been derived from this 
source. From the very beginning, moreover, our customs duties 
have been in spirit, if not always in effect, protective ; and it 
thus becomes necessary to consider the connection between the 
protective and revenue principles, in addition to the more 
strictly fiscal aspects of customs duties. 

Protective duties are imposed in the hope of diminishing im- 
ports and substituting in their stead the products of home manu- 
facturers. To the extent, therefore, that they are successful in 
their purpose, they reduce the customs revenues and justify the 
statement that there is a fundamental antagonism between the 
protective and revenue principles. However, the reduction of 



714 OUTLINES OF ECONOMICS 

importation does not signify that the consumers of the article in 
question are not taxed. So long as the price remains higher 
than it would be if no duty were imposed, the people are taxed 
to the extent of the difference, the proceeds of the tax going to 
home manufacturers in the form of an unmeasured, unregulated 
bounty, whose burden upon the taxpayers is no less real because 
unperceived. 

It is equally evident that no protection is given unless the price 
is raised. The popularity of customs duties is largely explained 
by the belief that the foreigner can be made to bear the burden 
of the tax. He can in some cases, but not in the majority of 
cases. For the most part it is very certain that the burden must 
be borne by the home consumer. But whatever the extent to 
which the foreigner can be made to pay the tax, to that extent 
the tariff fails to replace foreign by home products; in short, 
fails to " protect." We cannot have our cake and eat it too. 
The more the protection or bounty to the home manufacturers, 
the greater the tax upon the consumers, the less the shifting of 
the tax to the foreigner, and the less the revenue to the home 
government. The protectionist is logically deprived of the 
time-worn argument that the foreigner foots the bill. 

The European War has deeply impressed .upon the people of 
the United States the strength of the argument for protection 
based upon military grounds and briefly discussed on page 
370 above. It is likely, therefore, that we shall have more and 
not less protection in the immediately ensuing years, particu- 
larly for those industries whose products are believed to be in- 
dispensable to national security in times of war. So long as war 
is a real possibility there is probably no logical rejoinder to this 
argument for protection ; but at least we should realize that we 
are paying for our self-sufhciency, and that the difference 
between the cost of the protected products and what they 
would cost if imported from foreign countries, represents an 
additional item in the budget of " preparedness " which has 
already reached colossal proportions. 

The shifting of import duties may be best explained by noticing separately 
the immediate and ultimate incidence, (i) The immediate eifect of the tax 



FEDERAL, STATE, x\ND LOCAL TAXES 715 

will be to discourage certain foreign producers from shipping their products 
to the newly restricted market, and prices will tend to rise because of di- 
minished supply. If the product is controlled by a foreign monopoly, the 
price may not increase ; but where the foreign production take places under 
competitive conditions, and in most cases where the production is monopo- 
lized, the price will be raised. The increase of price may be more or less 
than or equal to the tax according to the rea'diness with which foreign pro- 
ducers find a new market, but in a large majority of cases the burden of 
the tax will be shared by the producer and consumer, the latter, according 
to the majority of authorities, bearing most of the burden. That the bur- 
den, however, is partially borne by the foreign producer accords not only 
with the best theory, but with the great interest displayed by exporters every- 
where in the tariff legislation of foreign countries, and the sacrifices which 
protectionist governments are willing to make in reciprocity treaties for the 
purpose of obtaining advantageous terms for their own producers. 

(2) Eventually, however, the initial increase in price may stimulate home 
production, and this can only take place when the increase of price is less 
than the duty, because if the price rises by the whole amount of the tax, the 
foreigner will still possess his initial advantage. If the home producer totally 
ousts the foreigner, then the consumer bears all the difference between the 
existing price and the price that would rule if no duty were imposed — 
although, of course, the treasury receives nothing. If the home producer 
secures only a part of the home market, it is plain that, under ordinary cir- 
cumstances, the foreigner pays part of the tax, i.e. the amount per unit of 
product by which the duty exceeds the increase of price; while, as before, 
the home consumer pays, on every unit consumed, a tax equal to the differ- 
ence between the old and the new prices. When, however, we attempt to 
go further and take account of the indirect effects of protection, the problem 
becomes almost hopelessly complex. Modern ■ economists, however, are 
substantially agreed that the foreign producer bears a somewhat larger share 
of the average customs duty than the English economists of the first half of 
the nineteenth century were willing to admit. 

From the standpoint of revenue, American customs duties 
have the great virtues of high productivity, convenience of pay- 
ment, and cheapness of collection. Along with these important 
virtues are associated almost all the vices to which indirect taxes 
are subject. 

I. The most important defects of our customs taxes are their 
unreliability and imcertainty . Historically, they have shown a 
pernicious variability, expanding when increased revenue spelt 
extravagance, contracting when the country sorely needed larger 
revenue. In 179I; for instance, the customs revenues exceeded 



7l6 OUTLINES OF ECONOMICS 

the total ordinary expenditures by over 41 per cent, while in 
the very next year they fell short of the expenditures by 58 per 
cent. Between 1791 and i860 inclusive, the customs receipts 
actually exceeded the expenditures in thirty-four years ; varied 
between 50 and 100 per cent of the expenditures in twenty- 
eight years ; and fell below 50 per cent in eight years. In i860, 
more than 84 per cent of the expenditures were secured from 
this source, but in 1863 less than 10 per cent, so inadequate is 
the customs revenue in a serious war when money is most 
needed. In 1864, Congress made desperate attempts to increase 
the customs revenue. In the tariif act of that year about fifteen 
hundred articles were enumerated, and the average rate approxi- 
mated 50 per cent; yet the receipts dropped from something 
over one hundred and two millions in 1864 to less than eighty- 
five millions in 1865, constituting only 6.5 per cent of the total 
expenditures in the latter year. During the history of the 
national government, the customs revenues have varied with 
the industrial condition of the country, the prospects of peace 
or war, the power of the tariff lobby, the prosperity and com- 
mercial policy of foreign nations, but almost never in nice accord- 
ance with the financial needs of the federal government. Where 
the tariff is controlled by revenue rather than protective pur- 
poses, it can be made strikingly stable and responsive to the 
control of the treasury. " The English revenue from this 
source has kept very near £20,000,000 per annum for the last 
thirty years. In the period 1815-1895, it has only varied be- 
tween £24,000,000 and £19,000,000, notwithstanding the exten- 
sive remissions of taxation." ^ 

2. From the fiscal standpoint, our tariff system is far too 
complex and cumbersome. Whether we tax many imports or 
few, the major part of the revenue comes from comparatively 
few imports, so that by extending the list of dutiable articles we 
merely add to the cost of collection and increase the interference 
with commerce, without materially augmenting the yield of the 
tax. Before the European War, Great Britain imposed import 
duties on less than fifty articles, and nearly all of her revenue 

1 C. F. Bastable, Public Finance, p. 517 (written in 1S95). 



FEDERAL, STATE, AND LOCAL TAXES 717 

from import taxation came from five articles : tobacco, tea, 
spirits, wine, and sugar. Compared with direct taxes the cost 
of collecting our import duties is not excessive (4.42 per cent 
of the receipts in 191 5), yet it exceeds the cost of collecting the 
internal revenue duties (1.50 per cent in 1915) ; and in some 
customs districts the expenses of collection actually exceed the 
tax collected. 

"There is no better illustration of a complex and incomprehensible 
revenue system than the tariii legislation of the United States. It levies 
import duties upon goods that make up the country's exports as well as upon 
those that constitute the normal imports of the nation's commerce ; it taxes 
raw material as well as the manufactured product, and the manufactured 
product itself is taxed at many stages in the process of its manufacture ; the 
rate imposed is determined in part by considerations of revenue, in part by 
the desire to grant 'incidental protection,' and in part for the purpose of 
prohibiting the import of selected articles ; the rules of rating are numerous, 
overlapping each other in many cases and resulting in a confusion of instruc- 
tions that necessitates a board of appeal in continuous session ; the text of 
the law makes a book of one hundred and fifty pages, while the law and its 
interpretation used by the officials as a guide in the performance of their 
duty is a volume of several hundred pages. A law of this sort cannot be 
comprehended." ^ 

Customs duties are either specific or ad valorem. Specific 
duties are laid in proportion to weight or number, without regard 
to value, while ad valorem duties are levied in proportion to the 
value of the commodities imported. Ad valorem duties are open 
to the objection that they offer a greater temptation to fraudu- 
lent valuations, and hence make more difficult the work of the 
customs officers. Specific duties, on the other hand, while they 
can be more easily administered, are open to the serious objec- 
tion that they impose a relatively heavier burden upon less 
valuable goods of any class. Owing to their greater ease of col- 
lection, however, such specific duties now play a larger part than 
ever before in our tariff system. 

Internal Revenue Duties. — In 1915 the internal revenue 
taxes yielded $415,681,024, or practically twice as much as the 
customs receipts for that year. Of the total collections just 

1 H. C. Adams, Science of Finance, pp. 409, 410. 



7i8 OUTLINES OF ECONOMICS 

one third came from the tax on spirits ; a httle less than one 
fifth (19 per cent in each case) from the taxes on tobacco, fer- 
mented hquors, and incomes, respectively ; a little less than one 
tenth from stamp taxes on documents and transactions ; and 
the remainder from taxes on oleomargarine and playing cards, 
back taxes, penalties, and the like. The internal revenues now 
include a number of taxes other than the familiar excises on 
articles of consumption which for so many years constituted, 
with customs duties, the fiscal mainstay of the federal govern- 
ment ; but these newer taxes will be left for separate notice 
and the remainder of this section confined to the excises on articles 
of consumption. Such excises are usually paid by stamps placed 
upon the package of sale, supplemented by license taxes upon 
dealers, which are also paid by stamps, as a rule, publicly ex- 
posed by the dealer in his place of business. 

Excise taxes, like all taxes, have their grave defects, (i) Like 
import duties, they m.ust be levied upon articles of wide con- 
sumption to be productive ; and as they are in a large degree 
shifted to the consumers, they frequently weigh more heavily 
upon the poor than upon the rich. (2) This regressivity is in- 
creased by the fact that the taxes are specific, not ad valorem, 
so that the finer grades of domestic cigars, for instance, pay a 
lower rate of taxation than the cheaper goods. (3) In order to 
prevent evasion of the tax, the government is compelled not only 
to watch, but partially to direct, the process of manufacturing 
at every step. Producers are required to give bond for the 
faithful observance of the law, to register raw materials which 
they buy, and to keep records of the stock on hand in accord- 
ance with bookkeeping methods prescribed for them by the 
Bureau of Internal Revenue. Such interference with private in- 
dustry is an unfortunate but necessary part of excise taxation. 
(4) Large systematized businesses bear such interference with 
less effort than small concerns, and in consequence our internal 
revenue system unquestionably exerts an influence in the direc- 
tion of large-scale production, and possibly in the direction of 
monopoly. The license taxes particularly, which are adjusted 
only in the roughest way to the size of the business, unquestion- 



FEDERAL, STATE, AND LOCAL TAXES 719 

ably weigh more heavily upon the small than the large dealers, 
(5) Finally, it seems to be the almost universal opinion of com- 
petent students that excise taxes exercise little influence upon 
the consumption of articles whose use is believed to be dele- 
terious. An increased tax is as often followed by adulteration 
as by an increase of the price per unit. 

The advantages of the internal revenue duties, however, far 
outweigh their defects, (i) Like the customs duties, they yield 
an enormous revenue ; but although they do fall off somewhat 
in times of industrial depression, they are in ordinary periods 
regular and dependable, while in times of war they respond 
readily to increased rates. The increase of old duties and the 
imposition of new duties during the Spanish War, for instance, 
raised the receipts from $170,900,641 in 1898 to $273,437,162 in 
1899. Many of the taxes yield a proportional increase almost 
as great as the increase in the rate of the tax, a rare virtue in 
excise taxation. (2) From the administrative standpoint they 
are very inexpensive to collect, give rise to comparatively little 
fraud or evasion, and the few industries which they affect have 
now become so habituated to public inspection and control that 
these are occasion of little complaint. (3) Finally, it is to be 
noted that although excise taxes are regressive, the burden of the 
tax is shared by producer and consumer — not borne wholly by 
the latter — and the share borne by the producer varies directly 
with the element of monopoly or differential advantage in pro- 
duction. " Viewed as a whole, the internal revenue system is 
the most satisfactory part of our entire financial structure, state 
or federal. Its returns are fairly steady and reliable in times of 
depression. Its growth is automatic. It is imposed on articles 
the demand for which is tolerably inelastic. Its burden is not 
perceptibly felt. It is honestly and economically collected; 
and finally, it is abundantly capable of yielding additional 
revenue, should an unforeseen emergency arise." ^ 

Taxes on Transactions. — In times of urgent need, as in the 
War of 1 81 2, the Civil War, and the late war with Spain, the 
federal government has imposed taxes upon various sorts of 

1 W. M. Daniels, Public Finance, p. 148. 



720 OUTLINES OF ECONOMICS 

transactions. Thus, the war revenue act of 1898 imposed stamp 
taxes on bank checks, telegrams, freight and express receipts, 
transfers of stocks and bonds, bills of exchange, etc. In 1899, 
the year after they were imposed, the stamp taxes yielded 
$43,837,819. Such taxes were again introduced in a period of 
declining customs receipts and increasing expenditures, by the 
so-called " war revenue act " of 1914. In 1915 this measure 
yielded a revenue of a little less than $38,000,000, of which 
$23,500,000 came from stamp taxes on documents and trans- 
actions and the balance from special internal revenue duties of 
the ordinary type. The peculiar advantage of taxes on trans- 
actions is their quality of immediate productivity. As the 
figures just quoted show, they may be made to yield largely 
the very year they are imposed. Moreover, the government 
may make evasion almost impossible by refusing to recognize 
documents not properly stamped in its courts, or by otherwise 
obstructing the use of unstamped documents as evidence. An- 
other advantage is that they cost almost nothing to collect, as 
the taxpayer buys the stamp himself and places it upon the 
document. On the other hand, the general effect of such taxes 
is to impede business ; and they are frequently if not usually 
shifted to the weaker bargainer in a business transaction. Cer- 
tainly they bear no logical relation to the ability of the taxpayer 
to pay taxes. 

Income Taxes. — The recent adoption of effective income 
taxation into this country affords an interesting illustration of 
the triumph of a sound economic idea over formidable obstacles. 
The legal barriers which had to be surmounted have already been 
mentioned, but there were other difficulties to overcome equally 
formidable. Income taxes had been on the statute books of 
American commonwealths since the seventeenth century, and 
had been consistently and continuously ineffective. The tax 
was generally believed to be too intricate and too inquisitorial 
for the American people, schooled by the crudities of the general 
property tax to evasion of and contempt for tax law. Expert 
opinion had come to hold that the income tax, though " sound 
in theory," made too many demands upon both the taxpayer 



FEDERAL, STATE, AND LOCAL TAXES 721 

and the tax administrator to thrive in American soil. Yet in 
the last five years income taxes of the European type have been 
put into successful operation by both state and federal govern- 
ments and give every promise of assuming, in the future, a place 
of major importance in the American fir-cal system. 

The mistake of the experts arose rather from an underestimate 
of the strength of the income tax than from an underestimate 
of its difficulties. The alleged weaknesses of the income tax 
were not imaginary. Experience has shown ^hat it is a complex 
and difficult tax to formulate and administer. Just what items 
of gross income should be included and what losses, expenses, 
and other deductions allowed, are questions which bristle with 
difficulties. Some forms of income are not expressed in money 
and usually escape taxation ; on the other hand, it is almost im- 
possible to avoid double taxation, particularly in dealing with 
interest and dividends. The tax has also the difficulty of 
being a class tax : the federal income tax touches directly less 
than one per cent and the Wisconsin income tax less than three 
per cent of the respective populations affected. The tax is 
predominantly a city tax and farmers generally escape, owing 
to the facts that they usually do not keep books and that much 
of their income does not find expression in terms of money ; 
although it must be admitted that relatively few farmers receive 
incomes above the exemption limit. Finally, the mixture of 
" withholding at source " and direct collection, in the federal 
tax, imposes large and unjust expenses of collection upon 
private taxpayers, complicates the administration of the tax, 
and in some cases leaves the taxpayer to become the sole judge 
of the taxability of certain items of income and of the deduc- 
tibility of certain losses and expenses. 1 

Despite all these difficulties, however, the income tax has 
succeeded. It is reasonably productive and will become more 
productive as time passes: the federal income tax in 1915 
yielded a revenue of over $80,000,000, and in 1916 it produced 

1 A criticism of the federal income tax by a disinterested and competent com- 
mittee of the National Tax Association will be found in the Proceedings of that asso- 
ciation, vol. ix. 



3A 



722 OUTLINES OF ECONOMICS 

over $100,000,000. It is elastic, and can be made more produc- 
tive by simple increase of rates. Above all else, it realizes with 
reasonable success " taxation according to ability." Property 
taxes pay little attention to the ability of the owner of the 
property. They fall upon property as such whether it is free or 
encumbered by debt ; they must be paid by the unsuccessful as 
well as the successful ; in lean years as well as fat years. The 
income tax, on the other hand, does not affect the very poor 
at all ; it spares the unsuccessful business, the new business 
in its developmental stage, and the old established enterprise 
in times of business depression. Its appeal is thus not only to 
the humanitarian sentiment of the age, but to the common 
sense of the business man. Except when collected at source 
(when it acts in small part like an excise) it is subject to little 
or no shifting. And, unlike the property tax, it grows stronger 
with age and continued use. The countries which have tried 
the income tax keep it ; and in the last quarter of the century 
practically every large country in the world which did not 
already have the income tax has introduced it. 

The mistake of the critics in condemning the income tax for 
American use was due very largely to a misinterpretation of the 
failure of the personal property tax. That tax is largely evaded. 
The critics inferred from this that American taxpayers are liars 
and would similarly evade an income tax. Experience with the 
income tax has shown, however, that the average American tax- 
payer is honest and will make an honest declaration if the tax 
be equitable and tax officials at the same time firm, competent, 
and considerate. The personal property tax in this country has 
failed, not because the taxpayer is dishonest, but because the 
tax is at times barbarously severe in burden, strikingly un- 
equal in operation, and administered by officials who are fre- 
quently incompetent and out of sympathy with the tax itself. 
Moreover, the income tax is no more complicated than any 
other direct tax involving valuation and assessment. It ap- 
pears to be more complicated than the property tax merely 
because in drafting income tax laws it is customary to anticipate 
all problems of detail and define the proper answer in the 



FEDERAL, STATE, AND LOCAL TAXES 723 

statute itself ; whereas, in property tax laws almost all the diffi- 
cult questions are avoided by laying the tax on the " fair cash " 
or '' market value " and leaving the meaning of this term to 
be decided by the judgment of the assessor. In the average 
case, it is easier to determine a man's income with reasonable 
accuracy than it is to determine with the same degree of accu- 
racy what his property is worth. 

Absentee ownership increases with industrial development, 
and much income is now derived from particular jurisdictions 
by persons who reside elsewhere. This leads in practice to 
double taxation, as both the jurisdiction in which the recipient 
lives and that in which the income originates are likely to im- 
pose the tax. Such double taxation is reduced as the jurisdic- 
tion is enlarged to which the income tax applies ; and for this 
reason many authorities advocate the exclusive employment of 
the income tax by the federal government. If the income tax 
cannot be employed by both state and federal governments, 
this conclusion is warranted. But we see no reason why the 
states should renounce the income tax and use substitutes which 
are manifestly inferior, merely because the federal government 
is employing the same tax. Nearly all taxes must be paid out 
of income. The specific tax employed is merely a device for 
distributing the tax. Why, then, should the state employ a poor 
method of distribution, such as that embodied in the personal 
property tax, when it might employ a tax which with substan- 
tial accuracy lays the burden in accordance with ability to pay ? 
As a matter of fact, the federal income tax is likely to encourage 
the adoption of state income taxes, because the federal tax fa- 
miliarizes the people with income tax procedure, and with 
simple modifications a report prepared for the federal govern- 
ment can be used for the state government. We should have, 
not hostility between state and federal administrations, but 
joint and cooperative use of many forms of taxation. 

Inheritance Taxes. — In 1893, when the first edition of this 
work was written, the inheritance tax was used in only five 
states, and so strong were the objections to its wide adoption 
that the author felt called upon to point out that unregulated 



724 OUTLINES OF ECONOMICS 

collateral inheritance was an unjustifiable survival of the clan 
system that was being carried to ridiculous lengths at that 
time. Since that time, however, inheritance taxation has spread 
rapidly, being employed in about forty states in 191 5, and with 
the spread of the tax has come a most significant development 
of progressive rating and taxation of direct as well as collateral 
heirs. Today one never hears of the " inherent right " of 
decedents to control absolutely the disposition of their property 
in perpetuity, and the right of the legislature to regulate in- 
heritance in behalf of the general social welfare is hardly dis- 
puted. Mr. Andrew Carnegie, for instance, advocates a rate of 
50 per cent upon the estates of millionaires. 

At present the inheritance tax produces substantial revenues 
in only a few states; in 1913, the latest year for which complete 
statistics are available, 35 states showed collections aggregat- 
ing $26,470,964, of which the six states of New York, Pennsyl- 
vania, Massachusetts, California, Illinois and Connecticut re- 
ceived 78 per cent. The important fact is that the initial in- 
ertia and opposition have been overcome and the ground cleared 
for the really efficient use of this tax as a means of reducing 
large fortunes and increasing public revenues. The new type 
of the inheritance tax is well illustrated by- the Wisconsin law, 
which applies to direct as well as collateral heirs, and which 
graduates the rates according to relationship and the amount 
of the individual share, and not by the size of the estate. The 
highest rate in the Wisconsin tax, applying to shares in excess of 
$500,000 given to distant relatives and strangers, is 15 per cent. 

Great as our progress has been in this respect, our legislation 
still falls short of the demands of common sense. Why should 
collateral inheritance, apart from a will, be permitted at all ex- 
cept among near relatives? Why should third cousins inherit 
from one another unless money is left by will ? Are third cousins 
nearer to one than the town or city in which one has lived and 
where one has been able to acquire a fortune? The extent to 
which intestate collateral inheritance is carried is a survival of 
the sentiment of the time when people lived in clans, and is 
illogical in our day. Right and duty should be coordinated. 



FEDERAL, STATE, AND LOCAL TAXES 725 

Ought I to be compelled by law to support an uncle who is un- 
able by incapacity to earn a livelihood ? Then I should inherit 
from him ; otherwise it does not seem clear that I should unless 
he leaves me property by will. So far as practicable the circle 
of legal duties ought, however, to be extended so as to include 
the circle of vital relationship. The property should go to the 
State in the absence of near relatives when no will is made. 
The clan is dead and forgotten ; ordinarily there is neither ac- 
quaintance nor recognizable obligation between second cousins, 
not to mention twenty-second. • Inheritances thus bestowed are 
pure gifts, wanton disturbances of existing abilities to use 
property. The modern clan is society, and to it belong all claims 
to inheritance falling outside the circle of vital relations. The en- 
lightened English jurist, Jeremy Bentham, wished to restrict 
inheritance and extend escheat, and thus abolish taxation 
altogether, but this is going too far. 

At present the inheritance tax in this country is too light to 
satisfy the requirements of sound inheritance taxation. The 
average inheritance tax, even in the case of large estates divided 
into large shares, is less than 3 per cent : and it is very difficult 
for one state to increase the rates if neighboring states do not 
do the same. Moreover, state inheritance taxes give rise to 
multiple taxation. Land devolves at situs, and its devolution 
is taxed at situs. But our most valuable land is rapidly pass- 
ing into corporate ownership, and corporations do not die. 
The corporate securities which represent the land are, under 
the inheritance tax, normally taxed at the domicile of the de- 
cedent. This is likely to be in another state. Hence many 
states, the western states in particular, try to tax not only the 
transfer of securities owned by resident decedents, but also 
the transfer' of securities " representing " property located 
within their borders. This is selfish and inconsistent. Both 
principles cannot find an equitable and logical place in the same 
tax law. But it is expensive and difficult to administer an 
inheritance tax on the " situs principle " ; and when a holding 
company or series of holding companies intervenes between the 
security and the tangible property which that security repre- 



726 OUTLINES OF ECONOMICS 

sents, it is almost impossible. Other states, again, tax the trans- 
fer of securities held in trust companies located therein ; while 
still others pile inconsistency upon inconsistency by giving 
bonds issued by their municipalities a situs within their own 
borders, in order that the transfer of such bonds may be taxed 
upon the death of their nonresident owners. The writer has 
known one block of securities to be taxed in three different 
states, and it was possibly taxed later in a fourth state. 

Under these circumstances, many people advocate as a 
remedy the collection of the tax by the federal government, 
with a redistribution of a part of the proceeds to the state 
governments. The principal argument for this change is the 
assertion that the federal government can, while the state 
governments cannot, realize the full possibilities of inheritance 
taxation, so that the federal government can give the states 
more than they are now receiving from this source and still 
retain a handsome revenue for federal uses. This project is, 
however, deeply resented by state tax officials, who point out 
that the probate courts, the natural machinery for administer- 
ing inheritance taxes, are in the hands of the state governments, 
and that there was considerable evasion of the inheritance tax 
adopted by the federal government during the Spanish War. 

We believe that the solution of the problem lies in cooperative 
and joint use by federal and state governments. Neither divi- 
sion of government can be prevented from using this tax, and 
fiscal necessity will almost certainly force the federal government 
to make use of it in the near future. That being the case, 
common sense points to the desirability of administrative co- 
operation, and the elimination by the larger sovereignty, if pos- 
sible, of double taxation arising from conflicts of jurisdiction. 

State and Local Taxation 

General Property Tax. — The key to the revenue system of 
our state and local governments, and by far the most important 
tax collected in the United States, is the general property tax, 
which supplied, in 1902, 82 per cent of the tax receipts of the 



FEDERAL, STATE, AND LOCAL TAXES 727 

state and local governments and 51 per cent of all taxes col- 
lected in the country, (i) national, state, and local. The most 
important characteristic of this tax is suggested by the word 
" general," — the tax is levied in principle upon nearly all property, 
real and personal, in the hands of the people. 

Though the administration of the property tax differs in many 
details among the states, it is the usual custom for assessors in 
each community to prepare complete statements of all kinds of 
taxable property owned by the people of the community. In 
some states the assessors receive from all residents sworn " lists " 
of property owned and subject to tax. By the terms of the law 
the property is supposed to be rated at its true full value, 
though, by the acknowledged practice of assessors and courts 
of review, the real rates vary widely from state to state, from 
community to community, and from individual to individual. 
On the basis of the property valuations thus made the state 
and local governments levy direct taxes at a rate fixed from 
year to year according to fiscal needs. The tax is then collected 
by local officers, and of the whole amount the portion levied by 
the county and state is passed on to the designated ofiicers 
after each minor political division has set aside its share. 

As yet few economists who have written upon the subject, and 
few state officers who have had to do with the administration of 
the tax, have ever been able to speak of it except in terms of the 
severest condemnation. Naturally, then, there is now a strong 
tendency to work away from this form of taxation. Some of 
the many serious faults which the general property tax has 
everywhere shown call for comment and explanation. 

I. Unjust Apportionment. — The first of the defects of the 
tax appears in the apportionment of the state's share of the tax. 
Each community has a narrow, selfish interest in reducing its 
assessment so that it may escape its just share of the tax. The 
same mean struggle is especially frequent between city and 
country districts. To correct the evil, boards of equalization 
are usually appointed, but experience has shown that such boards 
usually do their work in a most perfunctory way. Although 
earnest study of assessments may and sometimes does secure a 



728 OUTLINES OF ECONOMICS 

substantially just apportionment between county and county, 
this equalization does not correct the glaring inequalities within 
particular counties, and even within single assessment districts. 

2. Inequality as between Realty and Personalty. — In the 
second place, the general property tax has proved grossly in- 
equitable in laying an undue proportion of its burden upon real 
property, allowing various forms of personal property to escape 
with a slight tax or with no tax at all. A secondary result of 
this inequality is that the rural districts bear a disproportionate 
burden, since the greater part of the tax-escaping personalty is 
owned by the wealthy citizens of our cities. 

3. Undervaluation of Lar^e Properties. — Very similar to the 
preceding evils is the further injustice wrought by the tax 
through the disproportionate assessment of large and small 
properties. Thus, an investigation in Virginia covering over 
sixteen thousand pieces of property, showed that while the 
average ratio of assessed to true value was 33 per cent, parcels 
worth less than $500 were assessed at 47 per cent of full value, 
and parcels worth more than $10,000 at only 28 per cent of 
full value. ^ 

4. Temptation to Dishonesty. — It follows from the evils 
already described that the general property tax leads to a shock- 
ing amount of dishonesty, perjury, bribery, and other forms of 
corruption. Indeed, as one writer has expressed it, " The 
general property tax has gone far toward making perjury re- 
spectable and even virtuous." 

5. Fundamental Theoretical Defects. — But the most funda- 
mental defect of the general property tax is found in the fact that 
it is an incongruous mixture of real and personal taxes. Real 
estate, in a great majority of states, is taxed at its situs, irrespec- 
tive of ownership or the tax-paying ability of the owner. The 
personal obligation of the owner to support the government 
under which he immediately lives is met practically everywhere 
by that part of the tax which falls upon personal property, per- 
sonal property paying at the domicile of the owner. 

This distinction between real and personal property is artificial, 
^Report of the Joint Committee on Tax Revision (Virginia), 1914, p. loi. 



FEDERAL, STATE, AND LOCAL TAXES 729 

inequitable, and illogically applied. Personalty, as a measure of 
ability to pay taxes, ought to be accurately computed by offset- 
ting liabilities against assets, so that the taxpayer would pay 
only upon net assets. Yet no state, with the possible exception 
of New Jersey, grants full and complete exemption of debts; 
only three states permit a subtraction of debts from all per- 
sonalty ; the rest either refusing any abatement for debts what- 
soever or limiting the abatement to subtraction of debts from 
money, or money and credits, or other restricted classes of per- 
sonalty. Moreover, nearly all the states manipulate their defini- 
tions of real property in the most discreditable manner, causing 
many kinds of double taxation. To take a single illustration : 
most states tax the stock of foreign corporations held by resi- 
dent citizens, whether the corporation pays full taxes at its situs 
or not. Many of these states tax their own or domestic corpora- 
tions at full value, thus indorsing the theory that a corporation 
should be taxed as a business unit where the business is carried 
on. Nevertheless, they attempt to tax the stock of foreign cor- 
porations when the stock is the only thing they can reach. 
Some states, though not a majority, actually tax both the shares 
of stock and the business of domestic corporations, and then 
wonder that the stockholders attempt to evade the inequitable 
obligations imposed upon them by law. 

Reform of the Property Tax. — This brief outline of the evils 
connected with the general property tax furnishes us with the 
key to reform. By far the greatest reform that could possibly 
be accomplished would result from placing the work of assess- 
ment on a scientific basis, by appointing expert assessors under 
civil service protection, who would give their whole time to the 
business and hold their places during good behavior. In 1902 
practically three fourths of the revenues collected under the 
general property tax came from the tax on real property. We 
shall undoubtedly keep the real estate tax. Scarcely any one 
advocates its abandonment or believes that it will be possible 
to get along without it ; and with trained assessors it would be 
possible to make a substantially fair assessment of real property. 
Yet even the assessment of real estate is in most places today 



730 OUTLINES OF ECONOMICS 

markedly unequal. We spend a great deal of time thinking out 
ambitious fiscal reforms that will remedy the present system by 
revolutionizing it, overlooking the fact that the remedy for the 
deepest and widest evil lies within our reach, neglected and un- 
availing, not because we are ignorant of its potency, but because 
we lack the will resolutely to apply it. 

At the same time, no assessor, however expert and well paid, 
can ever be expected to assess all kinds of personal property with 
even approximate accuracy. To persist in the attempt to assess 
all the property of every person is simply to debase public 
morality and convince assessors that nothing short of divine wis- 
dom will enable them to satisfy the requirements of the law. 
In short, the more intangible forms of personal property, if not 
all personal property, must be exempted from taxation, and the 
loss be made up by the introduction of simpler and more work- 
able taxes. Probably the best substitute is an income tax, or 
what has been called a " presumptive ability tax " based upon 
house rent, rental value of business premises, salary, or all of 
them. In individual cases such a tax would violate the rules of 
exact justice, but with suitable exemptions and proper adjust- 
ments it might be roughly equitable. 

The personal property tax on business and commercial con- 
cerns, with its impossible requirements of stock valuations, 
taxation of book accounts, bills receivable, and credits generally, 
should be replaced by a tax on gross or net income, or by some 
simple form of license taxation. We should then have, in place 
of the general property tax, a tax on real estate, a business tax, 
and a personal tax measured by net income or evidences of in- 
come. Although the real estate tax would in appearance take 
no cognizance of mortgages or debts secured by the property 
and no account on the surface of the ability of the owner, it 
would not in reality wholly violate the canon of taxation accord- 
ing to ability. The man buying land on contract or subject 
to a mortgage, would take into account the fact that he would 
be called upon to pay taxes upon the whole value of the property, 
irrespective of debt or incumbrance, and the price would be 
adjusted accordingly. Or, if he mortgaged his land after he 



FEDERAL, STATE, AND LOCAL TAXES 731 

had acquired ownership, he would be indemnified in most cases 
for paying all the taxes, by receiving a lower rate of interest on 
his mortgage than he would be enabled to secure if the creditor 
were liable for taxes upon that part of the property covered by 
the mortgage. Real taxes, which take no cognizance of the 
financial status of the owner, are not inequitable when they are 
consistently applied and supplemented by a separate system of 
personal taxation. 

All these taxes destined to take the place of the general 
property tax may possibly, in the future, be assigned to the local 
governments, although administered in some cases by the 
central government. If necessary to provide enough revenue 
for the state, however, a small state tax could equitably be 
levied upon real estate, as the equalization of real estate assess- 
ments among the larger governmental divisions, such as coun- 
ties, is a comparatively easy matter. Whether the state will be 
able to get along without taxes upon real estate, depends prin- 
cipally upon the productivity of certain corporation taxes, the 
proceeds of which belong logically to the state rather than to 
the local governments. This absorption of corporation taxes 
by the state is already well under way in the New England and 
Middle Atlantic states. In 1915, for instance. New York, New 
Jersey, and Pennsylvania together raised $70,078,685 from 
special property and business taxes (practically corporation 
taxes), but only $18,743,626 from the general property tax. 
In that year Delaware made no use of the general property tax 
at all for state purposes. However, the breakdown of the general 
property tax has by no means been accomplished yet. In all 
the states and territories in 191 5, 51 per cent of the total tax 
receipts came from the general property tax, 23 per cent from 
special property taxes, 22 per cent from business taxes, less 
than I per cent from poll taxes, and something over 4 per cent 
from miscellaneous licenses. These proportions are based upon 
state receipts. If local revenues were included, the general 
property tax would appear much more important. 

Corporation Taxes. — The exact way in which any corpora- 
tion should be taxed depends upon a great variety of considera- 



732 OUTLINES OF ECONOMICS 

tions, which vary from place to place and from time to time. 
In general, however, the following elements may be detected in 
the more progressive systems of corporation taxation : (i) The 
incorporation fee, justified by the clerical expenses of registering 
corporations and the value of the privileges granted to every 
corporation, the most important of which is that of limited 
liability. This charge should be imposed on all joint-stock 
companies, should vary with the amount of bonds as well as 
the amount of stock authorized, and should be small, unless 
the state desires narrowly to restrict the incorporation of com- 
mercial enterprises. (2) The franchise tax proper, to cover 
especially valuable privileges, such as the right to use the public 
streets or highways, granted to most public utility companies. 
This is essentially a contractual payment, a lease or royalty 
rather than a tax. It should be fixed in advance for a definite 
period at as high a figure or rate as is just, and, when fixed, 
should not, in justice to the corporation, be tampered with by 
the state. ^ In states having public service commissions power- 
ful enough to control rates effectively, this tax or payment may, 
and perhaps should, be relinquished in favor of correspondingly 
lower rates and better service. (3) The general property tax 
or some equivalent, designed to impose upon the corporation a 
burden equivalent to that borne by the average taxpayer of the 
district. Inasmuch as good will, business organization, and 
similar intangible assets are property, property taxes imposed 
under this head should cover not only tangible but intangible 
values as well, including the franchise, when this does not revert 
to the state. Corporations which have received valuable fran- 
chises from the state may properly be called upon to pay for 
the privilege (under 2) as well as tipon the privilege (under 3). 

This differentiation of what may be called the bases of cor- 
poration taxation should not be misunderstood. Many states 
merge two or even three of these charges in a single tax, and 

1 However, where a long or perpetual franchise is given, provision should be made 
for the readjustment of the rental by arbitration or in some other equitable way. 
An illustration is found in the terms of the franchise under which the Pennsjdvania 
railroad built a tunnel under the North River and erected its new station in New 
York City. 



FEDERAL, STATE, AND LOCAL TAXES 733 

other states exempt savings banks, insurance companies, and 
other kinds of corporations from one or ail of these obhgations 
in order to encourage thrift or foster the industry exempted. 
Such exemptions are often justifiable and socially helpful. But 
unless these separate elements are kept plainly in mind, injus- 
tice is almost sure to follow. To impose, or try to impose, 
charge (2) upon all corporations, on the theory that all of them 
have received exceedingly valuable privileges, is to confuse 
general with special corporation privileges, and to pave the way 
for " corporation-baiting." Finally, although it is not neces- 
sary, we believe real progress will be hastened by observing 
these distinctions in practice as well as in theoretical analysis. 

Business and License Taxes. — In most Southern states 
there is an extensive system of business licenses, which supple- 
ment and partly replace the general property tax. The sig- 
nificance and importance of these business licenses have not 
hitherto been sufhciently appreciated. They are levied in 
theory under the regulative power of the government rather 
than the taxing power ; but they have by extension and multi- 
plication become taxes for the most part, as distinguished from 
sumptuary charges or payments for small privileges. 

The license system of the South is characterized by many 
defects. Here and there traces of class feeling are discerned, 
as in the prohibitive license taxes levied upon peddlers ; and 
the rates employed are often illogical, inconsistent, and in- 
equitable to the point of absurdity. In a few cases also, these 
taxes are high enough to bar certain occupations to the man 
with small capital. But on the whole they are among the best 
taxes employed by American commonwealths. They are easily 
and cheaply collected, very productive, cause little or no com- 
plaint, are not excessive as a rule, and exercise little or no in- 
fluence upon prices. And in so far as they discourage the 
excessive multiplication of small retail shops they perform the 
useful service of preventing almost inevitable loss and bank- 
ruptcy. 

The great significance of the business license is its expression 
of the truth that the general property tax in its crude form is 



734 OUTLINES OF ECONOMICS 

unsuited to the taxation of business. Under the property tax, 
business in general is taxed upon its tangible assets, i.e. fixed 
plant and stock. One has only to think of the varying relation- 
ship to taxable capacity of the plant and stock of a manufac- 
turer, a grocer, a druggist, and a stock broker, to realize the 
grave injustice of this method of taxation. In countries of con- 
tinental Europe, and in parts of Canada, as in the southern part 
of the United States, a wide and generally satisfactory use is 
made of the business tax. Eventually we shall probably come 
to the same thing in all parts of this country. But the tax 
should be adjusted to earnings or profits in a more effective 
way than is now done in the South. 

Poll Taxes. — The poll tax is the oldest tax we have in this 
country, and throughout the greater part of the colonial period 
yielded more than any other source of revenue. It aroused bitter 
opposition in many commonwealths and was prohibited by the 
liberal constitution of Maryland at the beginning of the Revolu- 
tionary War; but it persisted in many of the states, and still 
remains the most important source of revenue, after the property 
tax, in a few of the Southern states. The tax still stands on the 
statute books of about one half of the states, and is nominally 
employed as a highway or local tax in a still larger number of 
commonwealths ; but in many places little or no effort is made 
to enforce it. In Wisconsin, for instance, no attempt is made 
to collect the poll tax in more than half of the local taxing dis- 
tricts. The poll tax is not only difficult to collect, but is regres- 
sive and, when its payment is required as a prerequisite to the 
exercise of the suffrage, often results in widespread political cor- 
ruption. " No concealment need be made of the fact that the 
poll tax is used in Mississippi as a means of disqualifying the 
negro in national elections and controlling the vote in local 
elections." ^ The aggregate yield of the poll tax is small, and 
the expense of collecting it is relatively high. It has few de- 
fenders among competent students of taxation. 

1 C. H. Brough, in "Studies in State Taxation," Johns Hopkins University Studies 
ill Historical and Political Science, vol. xviii, p. 213. 



FEDERAL, STATE, AND LOCAL TAXES 735 

A Balanced Revenue System 

There are, on the mainland of the United States, forty-eight 
separate sovereignties in addition to the federal government, and 
the resulting conflicts of jurisdiction gives rise to the deepest 
defects of our revenue system. As a remedy for this evil, many 
authorities recommend a division or separation of revenues, by 
which certain taxes would be assigned to the federal govern- 
ment, others to the states, and still others to the local govern- 
ments. This plan is usually referred to as the " segregation or 
separation of the sources of revenue." 

The benefits that might be derived from a thoroughgoing 
system of segregation are many and obvious. But the trend of 
events suggests that reform must, in the main, be sought along 
other lines. The boundaries between state and federal finance 
become more indistinct with the passage of time. Both federal 
and state governments have recently adopted income taxes, and 
the federal government may very soon deem it wise to adopt the 
inheritance tax. The state governments in recent years have 
made increasing use of stamp taxes and other forms of excise 
taxation theretofore used almost exclusively by the federal 
government. In commonwealth finance, similarly, there seems 
little disposition to separate clearly the sphere of state and 
local taxation. On the contrary, state tax commissions are 
being given increasing powers of regulating local taxation, and 
it is being recognized in increasing degree that to finance the 
state governments by corporation and indirect taxes which do 
not touch the great mass of citizens directly, stimulates ex- 
travagance on the part of the state legislature, and, in fact, 
leads tc the reintroduction by the state of direct taxes on 
general property. Furthermore, there are some manifest ad- 
vantages in the joint use of the same tax by several divisions of 
government. The central or larger jurisdiction not only finds 
it possible to employ expert aid, which the local government 
could not afford to hire, but it has a broader, more impartial 
point of view which serves to check local selfishness. Local 
authorities, on the other hand, frequently have a helpful knowl- 



736 OUTLINES OF ECONOMICS 

edge of important facts and conditions which are likely to 
escape the agents of the central government. Joint use of the 
same tax also permits a wise compromise between central effi- 
ciency and the American demand for " local self-government." 

A certain amount of segregation is, however, not only expe- 
dient but plainly necessary. Thus, the use of import and export 
duties is confined by the constitution to the federal government. 
In the domain of commonwealth government also there are cer- 
tain enterprises, such as sleeping car companies, whose property 
or business is so difficult to localize that by common consent 
such companies are reserved for state taxation. For the same 
reasons, certain other corporations, such as telephone, telegraph, 
insurance, freight line and equipment companies, should be, and 
rapidly are being, set aside for state or central taxation ; and in 
the case of most " state- wide " public utilities there is obvious 
need for central assessment. In the past, it was common to 
assess separately the property of railroads and similar public 
utilities in every tax district (including townships and even 
school districts) in which they operated, and this absurd mor- 
cellement is still practiced in some backward states^ including 
New York. Many of the most important properties of such 
corporations cannot be intelligently valued without reference 
to the earnings or success of the business as a whole and this, 
as well as considerations of administrative simplicity, makes 
valuation or assessment as a unit obviously desirable. When the 
central valuation is once made it is possible in some cases to 
distribute or apportion the valuation to counties or other large 
local subdivisions ; but it is impossible to localize some busi- 
nesses satisfactorily, and minute subdivision is in all cases un- 
desirable. 

Much that has been said above about state versus local 
assessment applies, in the case of interstate corporations, to the 
question of federal versus state assessment. Without federal 
control each state is tempted to select that form of taxation and 
to adopt that method of dividing or allocating corporate prop- 
erty and business for purposes of taxation which is most bene- 
ficial to itself. Under such circumstances some interstate cor- 



FEDERAL, STATE, AND LOCAL TAXES 737 

porations are taxed upon more than one hundred per cent of 
their property or business, while others take advantage of the 
absence of authoritative central control to assign, in their own 
accounting systems, excessive proportions of property and 
business to those jurisdictions in which taxes are lightest. 

While federal regulation is justified by the same logic which 
sanctions state regulation of local taxation, it is very doubtful 
how far federal regulation can or should go. If the national 
government should require some form of federal incorporation 
for companies engaged in interstate commerce, it is possible 
that it would have power thereafter to prescribe the methods 
by which such interstate companies should be taxed under state 
law. This has been done in the case of national banks, although 
the power of the federal government to control taxation of 
national banks is clearer and probably greater than its poten- 
tial power to limit the rate of taxation of ordinary business cor- 
porations engaged in interstate commerce. But if the proposed 
federal regulation were elastic enough to permit the rate of 
taxation to vary in each state with the average level or burden 
of taxation in that state, and vigorous enough to suppress selfish 
state aggrandizement, it would represent a great reform. No 
form of federal control is expedient, however, that would de- 
prive the states of adequate revenues from this source. The 
properties of interstate companies form a very large part of 
existing wealth. In a number of states one tenth or more of 
the entire taxes collected, state and local, come from railroad 
companies alone. Commonwealth revenue systems are ad- 
justed to this condition and no revolutionary change is either 
practical or desirable. 

One important reform, however, could be accomplished at 
once. The Interstate Commerce Commission, or some similar 
federal agency, should at the earliest practicable date be directed 
to formulate and enforce some simple plan of allocating the 
revenues and expenses of interstate corporations to the several 
states in which they operate. This is required not only for the 
fair assessment of state income taxes, but for the valuation of the 
properties of interstate corporations, as these properties can 
3B 



738 OUTLINES OF ECONOMICS 

never be satisfactorily appraised without taking their earnings 
into account. 

For reasons which appear in the preceding discussion, it would 
be misleading to formulate any clear-cut division of taxes 
among the federal, state, and local governments. A few forms 
of revenue will unquestionably be reserved for the use of one 
branch of government, but the pressure of increasing expendi- 
ture is likely to force a joint use of such major revenues as taxes 
on real estate, income and inheritance taxes, excise and stamp 
duties ; and for these the ideal is joint administration, in which 
the relative impartiality and vigor of central administration 
may be supplemented and perfected by the more intimate 
knowledge of local ofBcials. 

QUESTIONS 

1. Why are the terms "direct" and "indirect" taxes particularly vague 
and equivocal ? 

2. Explain why no protection is given the home producer when the im- 
port duty is shifted upon the foreigner. 

3. What is the greatest fiscal defect of American customs taxation ? Can 
this defect be remedied ? 

4. Are excise taxes ethically justifiable? Do they materially check con- 
sumption when imposed upon alcoholic beverages and tobacco? 

5. Do you know of any state which levies an income tax at the present 
time? Is the tax successful? 

6. Should income which is saved and immediately reinvested be taxed? 
Is it not double taxation to tax savings and the earnings from such savings 
as well? 

7. Should corporations be taxed at the same rate as unincorporated 
business concerns? Should any definite relation between the two kinds of 
taxes be maintained? 

8. Contrast the taxation of national banks in your own state with the 
taxation of trust companies, ordinary commercial or manufacturing corpora- 
tions, and unincorporated business concerns. 

9. State as many reasons as possible why the separation of state and 
local revenues would be helpful. 

10. Explain why many forms of property employed in business cannot 
be inteUigently assessed for taxation without reference to the earnings of the 
business. 

11. Are assessors elected or appointed in your own state? Do they re- 
quire taxpayers to declare their personal property in great detail? Do the 



FEDERAL, STATE, AND LOCAL TAXES 739 

local assessment rolls contain separate figures for real estate and improve- 
ments? Is the property of nonresidents specially designated? 

12. Why is the general property tax particularly unsuited to the taxation 
of business and professional men? 

13. Should the federal government, if it possesses the power, make the 
taxation of interstate commerce corporations uniform throughout the United 
States ? 

REFERENCES 

Bullock, C. J. Selected Readings in Piiblic Finance, Chaps, vii-xix; "The 
Taxation of Corporations in Massachusetts," Quarterly Journal of. 
Economics, Vol. xxi, pp. 181-246. 

Commissioner of Corporations. Reports on the Taxation of Corporations ; 
Special Report on Taxation. 

Ely, R. T. Property and Contract in their Relations to the Distribution of 
Wealth, Chap. xvii. 

Hollander, J. H. (ed.), "Studies in State Taxation," Johns Hopkins 
University Studies in Historical and Political Science, Series xviii. 

Industrial Commission. Report. "Taxation," Vol. xix, pp. 1031-1069; 
"Taxation in Various States and in Canada with Special Reference 
to the Taxation of Corporations," Vol. xi. Part vii; "Taxation of 
Transportation Companies," Vol. ix, pp. 1006-1091. 

Reports of State Tax Commissions. Upon the topics indicated see "The 
Massachusetts Tax System and its Workings," Massachusetts Com- 
mission of 1897, pp. 1-73; "Public Service Corporations," Wisconsin 
Commission, 1901, pp. 72-121; "Taxation of Credits," ibid., 1903, pp. 
88-144; "Mortgage Taxation," ihid., 1907, pp. 303 et seq.; "Railway 
Taxation," Ontario Commission, 1905 ; Committee on Taxation of the 
City of New York, 191 5 ; Massachusetts Special Commission on Taxa- 
tion, 1915. 

Seligman, E. R. a. The Income Tax. 

West, Max. The Inheritance Tax, Chaps, vii and ix. 



APPENDIX A 

HISTORY OF ECONOMIC THOUGHT 

Economic Ideas in the Ancient World. — The assertion is some- 
times made, or at least the impression is frequently given, that there 
were no writings on economics before Adam Smith. This impression 
is erroneous, and derives its plausibility from the fact that before 
Adam Smith economic subjects were treated either disjointedly 
and in a monographic way, or else in connection with ethics and 
pohtical philosophy. But in treating economics in connection 
with ethics and politics, the older writers were merely following an 
instinctive method of dealing with economic truths, to which in a 
certain degree later writers are returning. Indeed, if we are to 
derive the utmost possible benefit from this brief survey of the devel- 
opment of economic thought, it is necessary to begin many cen- 
turies before Adam Smith, with the Greeks. 

The Greeks. — The three writers among the Greeks most inter- 
esting to the economist are Plato, Aristotle, and Xenophon. Both 
Xenophon and Aristotle (or, more probably, some unknown dis- 
ciple of Aristotle) have treatises upon the specific subject of (Eco- 
nomics, but these are devoted principally to domestic economy, or 
the management of the household ; and the more important eco- 
nomic ideas of the Greek writers are derived from their works which 
deal primarily with political and ethical subjects. 

Plato describes a Utopia in his Republic. His aim was to picture 
an ideal society in which the ills of society were to be corrected by 
a communistic State, and he included a communism even of wives 
and children, going farther than modern communists. The com- 
munism of Plato admitted, strange as it may seem, slavery, on 
which his social superstructure indeed rested as a base. The Laws 
of Plato is a more practical work. It aims to present not the best 
possible state, but a more practicable one, and deals to a greater 
extent with existing institutions. 

Aristotle's principal work for us is the Politics, and it is indeed 
one of the most remarkable books in the world's history. Its in- 
fluence is strongly felt today, for it was carefiilly studied by theo- 
logians of the Middle Ages, and through them entered into the thought 
and life of their time ; and the thought and life of their time can be 
seen by the careful student to have entered in a thousand ways into 
the institutions of the twentieth century. 

While Plato tacitly accepted slavery, Aristotle actively defended 
the institution of slavery, describing the slave as an " animated 

741 



742 OUTLINES OF ECONOMICS 

tool," and insisting that slave labor was necessary in order that the 
ruling classes might have the leisure for statecraft, art, and litera- 
ture. Both Plato and Aristotle, also, fully appreciated the advan- 
tages of the division of labor, and understood, in consequence, that 
a certain amount of traffic and exchange is necessary. But both 
writers shared the common prejudice against trade and commerce ; 
what one man gained in exchange, they thought, some other man 
lost ; and to live by trade was in their eyes despicable. Aristotle, 
moreover, defended the institution of private property, and formu- 
lated surprisingly accurate ideas about money and its functions; 
but he condemned interest taking because, as he expressed it, money 
is barren. 

Perhaps the most characteristic quality of Greek economic thought, 
speaking generally, is the thorough subordination of economic to 
ethical and political considerations. The object of life, in their 
view, was self-knowledge or self-realization, not the acquisition 
of riches, and they refused to regard wealth as an object of funda- 
mental importance to either the individual or the State. Plato, 
indeed, in certain parts of his writings, defends the ascetic idea that 
human wants are to be satisfied, not by the improvement of produc- 
tive processes, but by the repression of the wants themselves. 

The Romans. — While the economic institutions of the Romans 
and the manifestations of their character in their economic life will 
repay investigation, they were not remarkable for independent 
thought. Their economic ideas, like their philosophical doctrines, 
were borrowed fro.m the Greeks, and show the same general char- 
acteristics which the ideas of Plato and Aristotle do. Commerce 
and trade were held in contempt, particularly when carried on in a 
small way. Interest taking was by some thought to be " as bad 
as murder." Agriculture, on the other hand, was esteemed to be 
worthy of the noblest citizens, and a " return to the soil " in later 
Roman times was frequently recommended as a cure for the pre- 
vailing degeneracy. Pliny said the great estates, the latifundia, 
together with slave labor and the destruction of the small inde- 
pendent farmer, caused the downfall of Rome. Among other agri- 
cultural problems discussed by the Romans were those of intensive 
versus extensive culture, and slave versus free labor. 

The jurists are, however, the most important of all. Whatever 
may be its imperfections, the Roman law, the corpus juris civilis, 
is the most remarkable legal system the world has ever seen and 
for training in careful and accurate statement is unsurpassed. Prob- 
ably, as a training for economic studies, Roman law is among the 
most valuable branches of learning. It gives us also invaluable 
information about the economic institutions of Rome. 

Christianity. — To the economic thought of the time Chris- 
tianity brought the revolutionary ideas of the dignity of toil and 
the equahty of men before God. The philosophy of the Stoics had 
brought analogous ideas to the attention of the restricted intellectual 
world of the day, but Christianity popularized these ideas. The 



APPENDIX 743 

clergy were encouraged to earn their livelihood by manual labor, 
and laymen were exhorted to free their slaves as soon as they had 
become Christians. With respect to money and trade, however, the 
effect of Christianity was to strengthen and impress the teachings of / , 
Aristotle. // 

The Middle Ages. — As the power of the Church increased, its 
economic ideas found more formal expression in the treatises of 
the schoolmen and medieval theologians who expounded the church 
or canon law. Indeed, in the corpus juris canonici we have a definite 
system of economic thought which, while it was largely theoretical 
and intended originally for the ecclesiastical courts, came in time 
to be widely applied in secular affairs through the power of the con- 
fessional, the pulpit, and the wide jurisdiction of the ecclesiastical 
courts. 

The doctrines of the canonists were derived, in part, from bib- 
lical injunctions against usury and the pursuit of wealth. The 
early Christian fathers frequently went so far as to condemn private 
property and set up the ideal of communism among the faithful. 
But this was only an ideal, and private property was early recog- 
nized as a necessary evil resulting from the fall of man. This ideal, 
however, was powerful enough to keep alive the doctrine that the 
maintenance of the poor was not a matter of philanthropy, but a 
binding obligation, in the words of Thomas Aquinas, the most dis- 
tinguished canonist, a debitum legale. 

Following the philosophers of Greece and Rome, and in sym- 
pathy with the scriptural attitude toward wealth, trade and com- 
merce were regarded as greatly inferior to agriculture and handi- 
work as a source of livelihood. It was still believed that what the 
seller made by trade the buyer necessarily lost. As commerce 
developed, however, trade had to be recognized by the Church. 
In doing so, the canon writers formulated the doctrine of justum 
pretiiim, that every commodity has a just price, or value, which it 
is sinful for the seller to exceed. The modern trade-vmion doc- 
trine of a fair wage, and the decisions of our courts concerning rea- 
sonable charges for gas, railway services, etc., illustrate the perma- 
nent necessity of ethical ideas of this sort. 

The next most important economic doctrine of the canonists 
was the condemnation of usury, which originally signified any loan 
interest, and not necessarily excessive interest. Their argument 
against interest was based upon scriptural strictures against usury, 
and upon Aristotle's argument that money is barren. Interest 
taking by the clergy had been prohibited as early as the fourth 
century; but in 1311, at the Council of Vienna, interest was pro- 
hibited " absolutely and universally," regardless of the civil law ; 
and by the middle of the fourteenth century, the prohibition of 
interest had, in many places, been incorporated into the civil law. 
Little by little, however, the Church was forced to change its atti- 
tude, and in the middle of the sixteenth century (1545) a statute 
was passed in England legalizing an annual interest rate not in 



744 OUTLINES OF ECONOMICS 

excess of lo per cent.^ By this time the teachings of the canonists 
were fast giving way to the doctrines of mercantilism. 

Economic Ideas in Modern Times. — Before the close of the 
sixteenth century, the temporal power of the Church had been 
undermined by the development of the great modern monarchies, 
and in economic thought religious considerations were replaced by 
political necessities. The problem of the Church — the universal 
establishment of the Kingdom of God upon earth — gave way' to a 
newer problem — the maintenance and aggrandizement of rival 
states. The latter were in pressing need of ready money with which 
to build navies and support armies. How to increase public revenue 
and national wealth became the absorbing questions of the time. 

Mercantilism. — The mercantile system, also called Colbert- 
ism, restrictive system, and commercial system, obtained from 
the early part of the sixteenth century until late in the eighteenth 
century, and its influence is still felt. Mercantilism is not, strictly 
speaking, the product of a school of political economists, but rather 
the name given to that economic policy of statesmen and to. those 
detached economic views of writers which prevailed during this 
period. Most prominent among the statesmen who were mercantil- 
ists may be named Colbert, of France, Frederick the Great, of .Prussia, 
and Cromwell, of England. Serra, an Italian, early in the seventeenth 
century presented a moderate and systematic statement of their views 
in a work entitled A Brief Treatise on Causes which make Gold and 
Silver abound where there are no Mines. Thomas Mun, in England, 
a generation later, wrote a valuable treatise from the standpoint 
of the mercantilists, called England'' s Treasure by Foreign Trade: or 
the Balance of our Trade the Rule of our Treasure, while Sir James 
Steuart's Inquiries into the Principles of Political Economy, published 
in 1767, may be regarded as closing the development of the theory 
of mercantilism. 

The principal characteristics of mercantilism — the efforts to 
increase the stock of precious metals within the country, to main- 
tain a favorable balance of trade, to increase the population and 
foster manufactures, if necessary at the expense of agriculture — 
have been described elsewhere, and need not be repeated at this 
point. In attempting to apply these theories, however, the states- 
men of this epoch instinctively turned to that instrument — the 
law — with whose use they were most familiar, and statutory re- 
strictions were multiplied until mercantilism in one sense became 
practically synonymous with governmental interference. Toward 
the end of the eighteenth century, however, the commercial posi- 
tion of England, for example, became so strong that many of her 
industries found themselves crippled and confined by the very laws 
which had protected their infancy, and a reaction against mercan- 
tilism set in. The reaction, naturally, took the form of a movement 
in favor of agriculture and against governmental interference in 
economic and industrial affairs. In obedience to the needs of anew 

1 See also p. 493, above. 



APPENDIX 745 

epoch, political economy lent itself to a propaganda in support of the 
doctrine of industrial liberty. 

The Physiocrats. — The reaction against mercantilism found its 
first thorough and scientific expression at the hands of the French 
physiocrats. Quesnay, a physician, Gournay, a merchant, and 
Turgot,^ the statesman, are their three principal authors. Polit- 
ically, the physiocrats taught the doctrine of natural laws and 
rights, and as a consequence loudly proclaimed the maxim of laissez- 
faire, that is, .that the government should not interfere with pri- 
vate enterprise. Economically, they exalted the importance of 
agriculture, and maintained that manufactures and commerce, 
which merely change the form or position of raw materials, are 
barren and unproductive (though useful when subordinated to 
agriculture) ; but that agriculture yields a net surplus — produit 
net — over and above the expenses of production. The physio- 
crats must thus be credited with originating the fertile economic 
doctrine of surplus value — a reward or premium appearing in pro- 
duction for which nature rather than man is responsible, and which 
is not required to induce men to put forth the effort necessary to 
produce wealth. 

Many of the other doctrines of the physiocrats follow logically 
from the primacy which they accorded to agriculture. Since agri- 
culture is the sole ultimate source of wealth, they maintained that 
the revenue of the State should be raised by a single direct tax — 
the impdt unique — levied upon land. All taxes must, they thought, 
in the end come out of rent anyway ; and it was better that the land- 
lord should pay them at once instead of waiting until they had 
passed through five or six hands and various profits had added to 
their amount. Naturally the physiocrats were ardent champions 
of free trade. They encouraged also the consumption of agricultural 
products, " in order that the produit net might be increased," and 
were generous champions of the importance and rights of the down- 
trodden peasantry. Pauvres pay sans, pauvre royaume; pauvre 
rgyaume, pauvre roi, was the borrowed motto of Quesnay's Tableau 
Economique, the most important treatise of the physiocratic school. 

Adam Smith. — In 1776 Adam Smith published his Inquiry into 
the Nature and Causes of the Wealth of Nations, the most influential 
economic treatise ever written. " The life of almost everyone in 
England, perhaps of everyone," said Bagehot, " is different and 
better in consequence of it." His writings are found to be very 
similar to those of the physiocrats, but further developed and modi- 
fied by his Scotch training and habit of mind. We find in Adam 
Smith the doctrines of free trade, non-interference, and natural 
laws, yet all stated more guardedly. Although he does not regard 
agriculture as exclusively productive, he does show a partiality for 
agriculture, for in this branch of production, he says, nature labors 

1 Turgot did not count himself a member of the economic sect or school which 
gave their views the name of "physiocracy," but his economic doctrines are very 
much like theirs. 



746 OUTLINES OF ECONOMICS 

along with man. He emphasized the importance of permitting 
each individual to follow his own self-interest as a means of pro- 
moting national prosperity, but he was not unmindful of the exist- 
ence of altruistic motives in mankind. He accords full recognition 
to the motives of sympathy and kindness in his Theory of Moral 
Sentiments. But the net result of Smith's teaching was to strengthen 
and emphasize the laissez-faire trend of economic thought in his 
time. " Two conceptions," said Arnold Toynbee, " are woven 
into every argument of the Wealth of Nations, the belief in the su- 
preme value of individual liberty, and a conviction that man's self- 
love is God's providence, that the individual in pursuing his own 
interest is promoting the welfare of all." 

Economic Thought in the Nineteenth Century. — The Classical 
School. — The economic philosophy which prevailed during the 
first half of the nineteenth century is variously designated as the 
classical, Ricardian, English, or orthodox school. The earlier 
authors of this period were Jeremy Bentham (1738-1842), Thomas 
Robert Malthus (1766-1834), David Ricardo (1772-1823), James 
Mill (1773-1836), and John Ramsay McCulloch (1779-1864). In 
aU of these writers we iind the utilitarian philosophy, a deductive 
method, and the feeling that the outlook for the mass of the laborers 
was not a hopeful one. They elaborated economic principles, sup- 
posed to be good for aU times and places, with the positiveness that 
one expects to find only in the inathematical or physical sciences. 

Bentham's great work was the formulation and propaganda of 
the utilitarian ethics, with its famous first principle or goal of 
social action — the greatest happiness of the greatest number. 

Malthus 's principal contribution, contained in his celebrated 
work, The Theory of Population, has already been discussed. While 
Malthus was himself a particularly charitable and benevolent friend 
of the working classes, his doctrine of population contributed more 
than any other single thing to make the political economy of the 
classical school harsh and gloomy. It seemed to say that although 
wages were low they could be no higher, because if by some fortunate 
chance wages increased, population was sure to multiply until the 
wage was forced back to the old level. Poor relief and trade- 
union activities were both useless. The woe of the poor was due to 
their own lack of foresight, and could be removed by the poor alone. 
It was taught " that he who brought children into the world without 
adequate provision for them should be left to the punishment of 
nature." The responsibility of poverty was thus thrust upon the 
poor themselves ; the rich were soothed with the assurance that they 
were not primarily responsible for the condition of affairs. Mathus 
himself, however, did not frame his doctrine in so remorseless a way. 
He recognized the importance of what he called " preventive checks " 
to the increase of the population. Mathus brought the results of 
elaborate historical and statistical investigations to the support of his 
doctrmes. 

Ricardo was perhaps the first economist who adequately realized 



APPENDtX 747 

the importance of the problem of the distribution of wealth. The 
backbone of his distributive system was the Malthusian law of pop- 
ulation. Ricardo believed that as population increased, society 
would be forced to resort to poorer and poorer soils in order to ob- 
tain food ; and as this took place an increasing share of the product 
of industry would go to the landlord in the shape of economic rent. 
The division of the remaining product between labor and capital, 
in Ricardo's view, was determined largely by the standard of living; 
that is to say, the laborer would receive enough to purchase the 
necessaries and conveniences required to support him and his family 
in their customary style of living, while the residue would go to 
capital in the form of interest and profits. Profits were thus the 
" leavings of wages." With the passage of time and the settlement 
of a country, then, Ricardo's theory of distribution taught that 
rent would absorb a larger and a larger share of the product, wages 
a constant or slowly increasing amount, while profits would dwindle 
both absolutely and relatively. 

Ricardo's principal work is caUed Principles of Political Economy 
and Taxation. It was published in 1S17, and in it Ricardo elaborates, 
although he did not originate, the usually received doctrine of rent, 
which, modified and developed, is the one presented in this book. 
His ideas in general have a markedly pessimistic tinge. Rent, 
he said, is due to the niggardliness, not to the bounty, of nature ; 
and his theory of distribution emphasized the natural diversity of 
interest between wage receivers and profit makers, and the antago- 
nism between the interests of landowners and all other classes of 
society. Personally he was a kind man, and sincerely devoted 
to the advancement of. humanity. Ricardo is remarkable for his 
power in the use of the abstract deductive method, and it is note- 
worthy that this distinction should attach, not to a professional 
scholar, but to one of the most successful bankers and brokers of 
his day. 

John Stuart Mill, who lived from 1806-1873, closed one period 
in the development of economic science and began another in Eng- 
land. He started as a thoroughgoing follower of Ricardo, pre- 
served the old doctrines of value, rent, and profits, and advocated 
laissez-faire as a general principle of political expediency. But 
in his later years MiU advocated the diffusion of property through 
the regulation and taxation of inheritances, indorsed the appro- 
priation by the State of the future unearned increment of land, and 
emphasized an important distinction between the production and 
distribution of wealth. " The laws and conditions of the produc- 
tion of wealth," he said, " partake of the nature of physical truths. 
There is nothing optional or arbitrary in them. ... It is not so 
with the distribution of wealth. That is a matter of human insti- 
tutions solely. The things once there, mankind, individually or 
coUectively, can do with them as they like. . . . The distribution 
of wealth, therefore, depends upon the laws and customs of society. 
The rules by which it is determined are what the opinions and feelings 



748 OUTLINES OF ECONOMICS 

of the community make them, and are very different in different 
ages and countries; and might be still more different, if mankind 
so choose." 

The old and the new doctrines found in MUI's Principles of Polit- 
ical Economy do not harmonize, however, and the result is a work 
one of the most valuable of modern times, yet full of inconsistencies. 
Nevertheless, Mill will always be regarded as the culmination of 
the school usually known as the English deductive or classical school. 
Most of the work of the school was deductive ; that is, they reasoned 
by singKng out a few main facts of the external physical world and 
human nature familiar to all, and showing how men must act under 
the guidance of these laws. None of these economists pretended 
that the few laws which they considered were the whole of human 
nature, though they have sometimes been interpreted as if they did 
so ; but they thought that the great multitude of motives which 
influenced men were too complex to be analyzed, and only one or 
two (chiefly self-interest) could " be reduced to any assignable law." 
Despite these limitations, the largest contributions that have been 
made to economic science came from the Enghsh classical school. 

Socialism. — Mill's change of heart resulted partly from his 
study of the sociahst writers, who voiced the earliest and most 
thoroughgoing protest against the views of the classical economists. 
Modern socialistic doctrine may conveniently be dated from 
WUliam Godwin's Inquiry concerning Political Justice (1793), al- 
though Godwin himself was more of an anarchist than a socialist. 
Godwin and the early French idealists and communists, — Cabet, 
Saint-Simon, Fourier, etc., — began the attack on the ethical and 
political views of the orthodox political economy. Later the attack 
was continued in a somewhat more practical and realistic way by 
writers such as WiUiam Thompson and Robert Owen in England, 
Bazard and Louis Blanc in France, Rodbertus, Lasalle, and Marx in 
Germany. The foundation of classical political economy was laissez- 
faire, and its doctrinal structure was built around the system of private 
capitalistic enterprise. Socialism in essence was a thorough protest 
against laissez-faire and the private ownership of property. Pierre 
Le Roux used the word " sociaHsm " in 1838 ^ with the very purpose 
of expressing the antithesis of individuahsm. 

In recent times, largely under the influence of Karl Marx, social- 
ism has acquired a distinctive economic theory of its own. Marx, 
in his work on Capital, was in most ways as abstract, deductive, and 
pessimistic as any of the classical school, but at bottom his whole 
theory was directed against those fundamental institutions of our 
social order which the classical economists took for granted. Marx 
has been credited by some with the discovery of the materiaHstic or 
economic interpretation of history, and the whole tendency of the 
modern scientific sociaHsts has been to emphasize the evolutionary 
standpoint. 

The Sociologists. — Among other influences which broadened 

1 It was used before this in England by the followers of Robert Owen. 



APPENDIX 749 

Mill's conception of economic science, and induced him to temper 
the rigor of his early teachings, were the works of Auguste Comte 
(i 798-1857), the founder of modern sociology. Comte was espe- 
cially severe in his criticism of the methods of the classical econo- 
mists. He denied, in particular, that it is possible to develop a 
helpfid science of economics distinct from history, ethics, and poli- 
tics. Not only must these fields, he maintained, be cultivated in 
common, but the work must be done by inductive, as distinct from 
deductive, methods. To the classical assumption that a universal 
science of economics could be formulated, true for all times and 
places, he opposed the theory that there is in society an ordered 
change or evolution, and that the capitalistic stage, to which the 
classical economies conformed, must be studied in connection with 
the past and the future. Economics, he particularly insisted, cannot 
be divorced from history. 

The Historical School. — This particular line of thought was 
taken up in Germany about 1850 by three young Germans, 
Roscher, Knies, and Hildebrand, who vigorously assailed the doc- 
trines of the classical school. They went back to the old premises 
— self-interest, private property, demand and supply — and traced 
out the historical development of economic life, coming to the con- 
clusion that economic policies were not absolutely, but only rela- 
tively, true. They denied that economic science can discover laws 
which hold true for all times and all places. They emphasized 
the importance of the inductive method, of minute investigations 
into facts, and the study of legal institutions, custom, and ethics 
in their relation to economic life, while most members of the school 
entertained a strong sympathy for policies of reform. 

Owing to the political ferment in Germany during the infancy 
of the historical school and the formation of the German Empire 
when this reaction against the classical economists was at its height, 
German political economy of the last half of the nineteenth century 
was impregnated with a striking nationalistic spirit which sepa- 
rated it even further from the cosmopolitanism of the English writers. 
The creation of a new state is almost invariably attended by the 
enactment of restrictive legislation, looking to the amalgamation 
of the diverse elements incorporated into the new state and the 
protection of its industries from foreign competition. Laissez- 
faire, under these conditions, is particularly difficult to maintain. 
The new national economy of Germany seemed to voice these politi- 
cal necessities. Like the classical economy of England, it was a 
creature of its own time and its own environment. 

The Economic Optimists. — The classical English economists 
have often been called pessimists. This is too strong a term, in- 
asmuch as they all saw hope for improvement. What can be said 
is that they developed pessimistic tendencies. Take it as we will, 
the Malthusian doctrine of population is tinged with pessimism, 
and so also is the Ricardian theory of distribution. In oppo- 
sition to English economists, there was developed elsewhere, about 



750 OUTLINES OF ECONOMICS 

the middle of the nineteenth century, a scheme of thoroughgoing 
economic optimism, and this was presented in a more unquahfied 
way by Frederic Bastiat (1801-1850), than by any one else. Bastiat 
was an ardent agitator for free trade and a popiilar pleader for the 
existing order against the attacks of socialists and anarchists, he was 
the author of numerous pamphlets, and at the time of his death 
was engaged on a. systematic treatise entitled Economic Harmonies, 
of which the first volume only was completed. According to 
Bastiat, there is no economic rent. The landowner does not 
receive an unearned income. What we call rent is simply a return 
for past investments of capital. The profits on capital also, accord- 
ing to him, are simply a return on past labor, and relatively to wages, 
a diminishing return. For it is a peculiarity of fabor stored up in 
those products which we call capital, that it continually diminishes 
in value as compared with present labor. In other words, wages 
are continually gaining relatively as compared with the profits of 
capital. Capital may gain absolutely on account of the increase 
in the amount of capital. Wages gain both absolutely and rela- 
tively. Value gives us the ratio of exchange between services. 
Economic gain is in proportion to economic service except that labor 
is progressively a gainer on account of the fact that man's present 
services (as seen in labor) increase in value as compared with man's 
past services as accumulated in capital. 

As Bastiat denied the existence of pure economic rent in the 
Ricardian sense, he also denied the Malthusian theory of popula- 
tion, holding that no proof could be adduced of a tendency of popu- 
lation to press upon the means of subsistence. The evils that we 
experience come, according to Bastiat, from man's interference 
with natural harmonies. Nature works things out well, and this 
is the best of possible worlds if we could only let nature have her 
way. 

Henry C. Carey, the American contemporary of Bastiat, held 
similar doctrines, and was apparently the more original man. If 
either one borrowed from the other, it must have been Bastiat. 
Probably neither one was guilty of any conscious plagiarism. 

The writings of the optimists had a considerable influence for a 
time in Germany, where they were developed and applied with 
uncompromising logic by men like Prince-Smith, Faucher, and a 
considerable number of others who were influential in the press 
and practical affairs rather than in academic life. In the United 
States these writings have had a great deal of influence upon a num- 
ber of early writers, among whom we may mention especially the late 
Arthur Latham Perry, long professor in Williams College, and 
Edward Atkinson, a weU-known statistician and writer of Boston. 

Early American Economists. — The reaction against the Eng 
lish economists, it is interesting to note, began earlier in the United 
States than in England or Germany. In the early part of the nine- 
teenth century, emphatic dissent from the English doctrines was 
voiced by a group of publicists, among whom may be mentioned 



APPENDIX 751 

Alexander Hamilton, Daniel Raymond, Matthew Carey, Hezekiah 
Niles, and Frederick List. Hamilton's work and views are well 
known ; Niles and Matthew Carey were pamphleteers of consider- 
able note in the first third of the nineteenth century; and List, 
who, in the view of some authorities, planted the seeds of the Ger- 
man historical school, unquestionably obtained his distinctive na- 
tionalistic views about political economy in the United States, and 
first formulated them in his Outlines of American Political Economy, 
published in 1827.^ 

Daniel Raymond, however, of aU the American writers noted, 
is the least known, and yet the author of the first American treatise 
on political economy in which a distinctively American system of 
economic thought is suggested. Raymond's first book. Thoughts 
on Political Economy, appeared in 1820 ; a second edition, under 
the title Elements of Political Economy, appeared in 1823, and the 
latter was reprinted with slight changes in 1836 and 1840. The 
essence of Raymond's system is found in his conception of wealth. 
Wealth, he maintained, is not an aggregate of exchange values 
but the opportunity to acquire the material comforts of life by 
labor. The English political economy, in Raymond's view, was 
a study of private as opposed to political or national economy. 
Raymond emphasized the distinction between individual and 
social wealth, and maintained that the laws of wealth laid down 
by Adam Smith were untrue of a nation conceived as a unit. The 
interests of particular individuals, or particular classes, he argued, 
do not always coincide with the interests of the nation as a whole, 
and the latter, he concluded, wiU be best advanced by developing 
all the national powers to their widest possible extent. He was 
thus a warm advocate of protection as opposed to laissez-faire. 

Raymond's views had so impressed Matthew Carey that he of- 
fered to support a chair of political economy at the University of 
Maryland if the University would permit Raymond to fill it. Mat- 
thew Carey's son, Henry C. Carey (i 793-1879), by far the most 
influential of the early American economists, was in like manner 
probably influenced by the teachings of Raymond. Carey was 
not only an earnest champion of protection, but an indefatigable 
critic of classical economic doctrines. He denied the truth of 
the Malthusian principle and the law of diminishing returns ; ob- 
jected to the Ricardian theory of rent ; and maintained that the 
value of a commodity depends upon the cost of reproduction rather 
than the cost of production, as was, he thought, laid down in the classi- 
cal theory of value. Carey entertained a concept of wealth very 
similar to that of Raymond, and in some parts of his work adopted 
methods of investigation which brought him in close touch with 
the sociologists and the German historical economists. The key- 
stone of his economic system is the doctrine of association. The 

^ List returned to Germany and was there a forceful writer and agitator for 
German unity, and is identified rather with the history of economic thought of 
Germany than with that of the United States. 



752 OUTLINES OF ECONOMICS 

increasing mastery of man over nature, or the increase of wealth, 
Carey held to be dependent upon the increasing efi&ciency resulting 
from a compact, homogeneous population, in which agriculture 
and manufacture are conducted side by side, in which the home- 
market idea is carried out in the most complete way, and in which, 
to be brief, the association of industrial and social units is most 
intense and intimate. It can be readily understood why the eco- 
nomic philosophy of Carey was so inimical to free trade at every 
point. 

The Austrian School. — The protests against the classical econo- 
mists which we have been considering were directed largely against 
the narrow scope and deductive methods of the classical school. 
The Austrian economists represent a reaction not against their 
methods, but against the conclusions, and particularly against the 
theory of value of the classical school. The great contribution of 
the Austrian school is the marginal utility theory of value, which 
has been most assiduously applied in economic analysis by a group 
of Austrian economists, among whom may be specially mentioned 
Menger, Wieser, Sax, and Bohm-Bawerk. But the marginal utility 
theory of value was advanced almost sim\iltaneously, about 1871, 
by the English economist Jevons, the Austrian economist Menger, 
and the French economist Walras.^ 

The Austrians have been a leading force in producing what is 
not inaptly termed a renaissance in theory, although, as stated, 
they indorsed the deductive and abstract methods of the classical 
economists. The classical theory put the emphasis upon supply 
or the conditions of supply, maintained that cost of production 
determines value, and found the ultimate measure and explanation 
of value in the pain and sacrifice of labor. The Austrians main- 
tain that utility, the pleasure or satisfaction derived from con- 
sumption, is the ultimate cause and measure of value ; they empha- 
size demand as the English economists emphasized supply ; and 
hold that value determines cost of production and not the cost 
of production, value. Capital, they conclude, receives its value 
from the finished product instead of giving value to that product. 
The work of this school has tended to put the consumer in the place 
primarily occupied by the capitalist as the center of discussion in 
economic theory. The work of the Austrians has had a profound 
influence upon economic writing in the United States. 

Present Condition of Economic Thought. — The net effect of all 
these protests against the classical English economists has been 
to introduce a welcome catholicity into the methods of economic 
investigation. The historical school emphasized the evolutionary 
standpoint and the necessity of minute investigation of the facts 
of industrial hfe, while the work of the Austrians operated to strengthen 
and explain the necessary place of deduction in economic analysis. 

1 In reality the marginal utility theory had been explained many years before 
this by a number of obscure writers whose ideas, however, never affected the main 
current of economic thought. 



APPENDIX 753 

Today the ordinary economist employs either method, or both, as 
the subject-matter demands, and the controversy about methods 
has become a thing of the past. With respect to the theory of value, 
neither supply nor demand, neither cost nor utility, neither the capi- 
talist nor the consumer, is now said to exert a predominating influ- 
ence in the determination of values. The Austrian school, it is now 
understood, supplied a needed corrective without revolutionizing 
the earlier theory of value. The Austrians themselves are seen to 
have been guilty of laying exaggerated emphasis upon the consumer's 
influence upon value and price, and there is reason, to believe that 
their analysis is based in some degree upon a faulty psychology. 

So, similarly, with respect to the scope of economics. The at- 
tempt of the classical economists to isolate an " economic man " 
ruled entirely by an enlightened self-interest and unaffected by 
political, ethical, and humanitarian impulses, is recognized to have 
been a mistake. But economics has never given itself to a com- 
plete study of politics or ethics. It considers ethical and political 
phenomena when these cannot be dissociated from economic phe- 
nomena, but insists, nevertheless, upon the separation of economics 
from ethics, politics, and sociology. We recognize that these fields 
are not wholly or clearly differentiated, but we recognize just as 
clearly that a division of labor is necessary if accurate results are to 
be achieved. Furthermore, this division of labor is showing itself 
progressively within the limits of economics itself, as it has shown 
itself in all growing sciences. Indeed, the present condition of eco- 
nomic thought was so accurately predicted by W. S. Jevons, in 1876, 
that his words — written in the midst of the controversy among the 
adherents of the deductive, historical, mathematical, and sociological 
methods of investigation — may weU be employed to picture the 
condition of the science of economics as it exists today : 

" As I have previously explained, the present chaotic state of 
economics arises from the confusing together of several branches 
of knowledge. Subdivision is the remedy. We must distinguish 
the empirical element from the abstract theory, from the applied 
theory, and from the more detailed art of finance and administration. 
Thus will arise various sciences, such as commercial statistics, the 
mathematical theory of economics, systematic and descriptive 
economics, economic sociology, and fiscal science. There may even 
be a kind of cross subdivision of the sciences ; that is to say, there 
will be division into branches as regards the subject, and division 
according to the manner of treating the branch of the subject. The 
manner may be theoretical, empirical, historical, or practical ; the 
subject may be capital and labor, currency, banking, taxation, land 
tenure, etc., — not to speak of the more fundamental division of the 
science as it treats of consumption, production, exchange, and dis- 
tribution of wealth. In fact, the whole subject is so extensive, 
intricate, and diverse, that it is absurd to suppose it can be treated in 
any single book, or in any single manner." ^ 

1 Jevons, Theory of Political Economy, 3d ed., pp. xv, xvi. 
3C 



APPENDIX B 

SUGGESTIONS FOR STUDENTS AND TEACHERS 

Some teachers of economics rely chiefly upon classroom discussions of 
assignments in a textbook, supplemented, possibly, by certain other 
reading requirements. Others make large use of lectures and of prob- 
lems and brief reports assigned in connection with particular subjects 
discussed in the class. Some require the student to write one or more 
longer essays or themes on specific topics. In this boolc specific refer- 
ences, questions, and problems have been appended to each chapter. 
The aim has been to list only books and papers that have value in them- 
selves and that have a direct bearing upon the subject matter of the 
respective chapters. References to parallel discussions in other elemen- 
tary textbooks have for the most part been avoided, the aim being to 
enable the student to extend his inquiries by reading more advanced and 
comprehensive treatments of particular problems. 

There is no one " best way " of teaching economics, for the methods 
used must depend very largely upon the size of the classes and the 
maturity of the students. It has been the experience of the writers, 
however, that whatever the relative degree of emphasis put upon 
lectures, classroom discussions, and assigned problem work of different 
sorts, mastery by the student of one book on general economics, or at 
least of so much of it as treats of fundamental economic principles, is 
an essential part of every introductory course in the subject. When 
pressed for time, the teacher using this book may find it desirable to 
omit all of it save Book II, " Principles and Problems." When more 
time is available, it may be deemed wise to include discussions of certain 
subjects not treated in this volume. " The economic problems of munic- 
ipalities," "the elements of statistical method," " the problems of poor 
relief," " the general principles of market organization," are a few among 
many possible supplementary topics. 

Valuable suggestions on the teaching of elementary economics will be 
found in various papers and discussions printed in the Journal of Political 
Economy, Vols, xvii-xxii (1909-19 14). Some help may also be gained 
from papers by C. J. Bullock {Education, Vol. xi) ; F. R. Clow {Economic 
Studies, Vol. iv) ; R. F. Hoxie {Journal of Political Economy, Vol. ix) ; 
H. R. Mussey {Educational Review, Vol. xi) ; and H. W. Thurston 
{School Review, Vol. iv). 

754 



APPENDIX 755 

The problem of making an adequate amount of supplementary reading 
available to students in large classes has been made easier to solve by the 
publication of volumes of excerpts, designed for this particular use. 
(W. tl. Hamilton, Current Economic Problems; L. C. Marshall, 
C. W. Wright, and J. A. Field, Materials for the Study of Elementary 
Economics ; C. J. Bullock, Selected Readings in Economics ; F. A. Fetter, 
Source Book in Economics.) Similar volumes have been made up of 
material on special economic problems. References to many of these 
will be found among the reading lists appended to the different chapters 
in this book. 

General Works on Economics. — Other American textbooks on 
economics, of college grade, are : C. J. Bullock, Introduction to the Study 
of Economics ; H. J. Davenport, Outlines of Economic Theory; F. A. Fet- 
ter, Principles of Economics; Irving Fisher, Elementary Principles of 
Economics; H. R. Seager, Introduction to Economics ; and E. R. A. 
Seligman, Principles of Economics. Larger in scope or more detailed in 
their treatment of the general principles of economics are H. J. Daven- 
port, Economics of Enterprise; F. A. Fetter, Economics (2 vols.)-; A. T. 
Hadley, Economics ; F. W. Taussig, Principles of Economics (2 vols.). 
F. A. Walker's Political Economy {" advanced course "), although pre- 
senting a somewhat antiquated view of economic principles, will be 
found still to possess much interest for the reader. 

Among English books, Alfred Marshall's Principles of Economics 
occupies a peculiarly authoritative position. It is characterized by an 
unusually intimate grasp of the facts of modern economic life and by a 
rare degree of ability in critical analysis. It attempts to reconcile many 
of the modern developments in economic analysis with the fundamental 
tenets of the political economy of David Ricardo and John Stuart Mill. 
Critics differ with respect to the degree of success with which Marshall 
has accompHshed this reconciliation. Marshall's Principles is difficult 
for any but the mature student, and his own attempt at an abridgement, 
his Economics of Industry, is distinctly inferior to the larger work. Two 
excellent books that are based in large measure on Marshall's Principles 
are S. J. Chapman, Outlines of Political Economy, and A. W. Flux, 
Economic Principles. The comprehensive English work of J. S. Nichol- 
son {Principles of Political Economy, 3 vols.) is even more conservative in 
matters of economic theory than is Marshall's. Edwin Cannan's 
Wealth is a small manual with an original and suggestive point of view. 
Distinctly the most readable and in many respects one of the best recent 
English works is P. H. Wicksteed's The Common Sense of Political 
Economy. 

Special mention can be made of only a few of the more important 
German and Austrian works on general economics. Adolf Wagner's 
Grundlegung der politischen Oekonomie (2 vols.) is characterized by great 



756 OUTLINES OF ECONOMICS 

erudition and by systematic and painstaking classifications and defini- 
tions. It is of particular interest to American students on account of its 
distinctive point of view, and especially its emphasis upon the general 
ethical and political aspects of economic problems. The Allgemeine 
Volkswirtschaftslehre of Gustav Schmoller (2 vols.) is characterized by 
the consistent use of the historical method, and by the extent to which 
psychology and ethnology as well as history are drawn upon to explain 
modern economic institutions. Wilhelm Lexis's Allgemeine Volks- 
wirtschaftslehre is a smaller work, embodying a better exposition of 
fundamental economic principles than is found in most German works, 
and distinguished by a large measure of originality. The Allgemeine 
Volkswirtschaftslehre of Eugen von Phillipovich (2 vols.) contains a more 
systematic presentation of general economics than does any other work in 
the German language. It is distinctly catholic, or perhaps, eclectic, 
in its general theories. 

The Traite theorique et pratique d'economie politique (4 vols.) of Paul 
Leroy-Beaulieu may be taken as the best example of a rather dogmatic 
type of laissez-faire economics that still commands a large and influential 
following in France. Representative of a newer school of thought,, more 
hospitable to various projects for constructive economic betterment, is 
the work of Charles Gide, whose two books on general economics are 
available in English translation (Political Economy and Principles of 
Political Economy). The best modern French work is, perhaps, Adolphe 
Landry's Manuel d'economique. 

In other European countries, especially in Italy, Holland, and the 
Scandinavian countries, there has been much economic writing of a high 
order. Attention may be called to the English translation of the excel- 
lent Dutch work of N. G. Pierson, Principles of Econo7nics (2 vols.), and 
to the French translation {Manuel d'economie politique) of a book (in 
Italian) by Vilfredo Pareto, which is possibly the most noteworthy of 
various modern works in which mathematical methods are used in 
economic analysis. 

Encyclopedias. — The most comprehensive encyclopedia of economics 
is the great H andworterbuch der Staatswissenschaften (3d ed., 7 vols.), 
edited by Conrad and others. A smaller, but useful, German reference 
work is the Worterhuch der Volkswirtschaft (3d. ed., 2 vols.), edited by 
Elster. In French, the Nonveau dictionnaire d'' economic politique (2 vols., 
with supplements), edited by Say and Chailley, is already somewhat 
antiquated and represents a rather narrow point of view. For special 
fields there are the Dictionnaire des finances (2 vols.), edited by Say and 
Foyot, and the Dictionnaire du commerce, de Vindustrie, et de la banque 
(2 vols.), edited by Guyot and Raffalovich. The English Dictionary of 
Political Economy (3 vols.), edited by Palgrave, is a standard reference 
work. There is no American dictionary or encyclopedia covering the 



APPENDIX 757 

whole field of economics. The Encyclopedia of Social Reform, edited by- 
Bliss, is useful in its special field. Although published in the early 
eighties, some of the articles in Lalor's Cyclopedia of Political Science, 
Political Economy, and United States History (3 vols.) remain of value. 
The newer Cyclopedia of A merican Government, edited by McLaughlin and 
Hart, may be consulted on topics in public finance and related fields. 

Periodicals. — Many of the most important contributions to eco- 
nomics appear in special periodicals devoted to the subject. In the 
United States there are the Quarterly Journal of Economics, the Journal 
of Political Economy (monthly), the Political Science Quarterly, and the 
American Economic Review (the organ of the American Economic Asso- 
ciation, quarterly). The Annals of the American Academy of Political 
and Social Science (monthly), the American Political Science Review 
(quarterly), and the American Journal of Sociology (bi-monthly), 
frequently publish papers that are of importance for the student of 
economics. Limited to more specialized fields are the Quarterly Publica- 
tions of the American Statistical Association, the American Labor Legis- 
lation Review, the Bulletin of the National Tax Association (monthly), and 
the Survey (weekly, covering the field of charities and other organized 
movements for social betterment). 

In England the principal economic periodicals are the Economic 
Journal (the quarterly organ of the Royal Economic Society), the 
Journal of the Royal Statistical Society (monthly), and the Economic 
Review (quarterly, largely devoted to the ethical aspects of economic 
problems). The economic journals of the various countries of conti- 
nental Europe, although of great value to the specialist, are too numerous 
to mention here. 

The " trade journals " of different special industries and in the fields 
of banking and insurance are often useful to the special students in these 
fields. In particular the periodicals dealing with the general conditions 
of business and the money market are often indispensable. The Com- 
mercial and Financial Chronicle of New York (weekly) may be specially 
mentioned on account of the completeness and accuracy of its statistics 
of money market conditions. For London the Economist and the Statist 
occupy a similar position. The Annual Financial Review contains con- 
venient compilations of the more important statistics that have appeared 
in the Commercial and Financial Chronicle during the preceding year. A 
useful annual survey of international financial conditions is given by 
Raffalovich's Le marche financier (Paris). Such annuals as the States- 
man's Year Book (London), Whitaker's Almanac (London), and the 
World Almanac (New York), are often useful for reference purposes. 
The American Year Book contains, among other things, an excellent 
annual review of important economic legislation. 

Reference to the enormous output of articles on economic subjects in 



758 OUTLINES OF ECONOMICS 

periodicals of a more general or popular type is now easy by using the 
" cumulative indexes " and " readers' guides " that will be found in most 
colleges and public libraries. These articles are, of course, of very uneven 
quality and must be used discriminatingly. Most of the more important 
current articles on economic topics are listed, with many brief abstracts 
or appraisals, in the successive numbers of the American Economic 
Review. 

Books in Special Fields. — The references given in connection with the 
different chapters in this volume are sufficient to enable one to make a 
fairly thorough study of the different subjects treated in these chapters. 
Many of the books referred to contain more elaborate bibliographies on 
their special subjects. The student should, of course, be familiar with 
the use of the card catalogue of a modern library. In using such a cata- 
logue it should be remembered that the library classification of books by 
subjects is very rarely entirely satisfactory, so that one should exercise 
one's ingenuity in searching und«r different subjects. The Library of 
Congress has printed in pamphlet form lists of books and articles on 
various practical economic problems, and is often able to furnish, at a 
small price, shorter typewritten lists of references on other subjects. 
Short annotated bibliographies are issued by different state legislative 
libraries and municipal reference libraries. The bibliographies in the 
various economic encyclopedias, especially the HandwUrtcrbuch der 
Staatswissenschaften, will often be found helpful. ' A very complete list of 
new books in various fields of econonaics is published quarterly in the 
American Economic Review. 

Government Publications. — The student should early acquire some 
familiarity with the use of government documents as first-hand sources 
of information. Aside from statutes and the proceedings of legislative 
bodies these publications include : (i) annual reports of different admin- 
istrative departments and bureaus ; (2) reports of special investigations 
made by the permanent bureaus or by special commissions ; (3) records 
of the hearings before legislative committees of inquiry. A record of the 
enormous output of the publications of the federal government is con- 
tained in the Monthly Catalogue of Public Documents, published by the 
Superintendent of Documents, Washington. This has an annual index, 
and a comprehensive Document Catalogue is also published for each 
Congressional period. The Check List of Government Documents is 
convenient to use in locating regular or routine documents published 
before 19 10. The Annotated Tables of and Consolidated Index to the 
Congressional Series of United States Public Documents may also be used 
for the same purpose. Poore's Descriptive Catalogue of the Government 
Publications of the United States, 1774-1881, is useful in locating irregular 
or obscure publications of various sorts. In nearly every congressional 
district there is a public or college librarj' which is an ofiicial depository 



APPENDIX 759 

for federal documents and 'has a nearly complete set of those published 
in recent years. Current documents may sometimes be obtained with- 
out charge from the departments or bureaus issuing them or from the 
Representative or Senator from one's district or state. They can 
always be purchased at small prices from the Superintendent of Docu- 
ments. The Superintendent of Documents issues small printed price 
lists of the publications in different special fields. 

The Library of Congress publishes a Monthly List of State Documents. 
Bowker's State Publications (three parts) give a fairly complete list up to 
about 1900, and a full index to the economic materials in state documents 
is being published by the Carnegie Institution. The volumes for a 
number of the larger states have already appeared. Municipal docu- 
ments are often published in an unsystematic way, and there is no 
general index or list of either current or past municipal publications. 
The student should find it both practicable and instructive, however, 
to become acquainted with the published documents of the city in which 
he lives, or those of some large city in his state. 

The British Parliamentary Papers contain a wealth of material on a 
wide range of economic topics. Much of this is listed in P. S. King & 
Son's Catalogue of Parliamentary Papers, 1801-igoo (with Supplement, 
igoi-igio). Lists of current publications are published by several Lon- 
don dealers. The more important ones are noted in the English eco- 
nomic Journals, and (more fully) in an occasional " Blue Book Sup- 
plement " to the New Statesman, a London weekly. Among the gov- 
ernment publications of other countries we can mention here only the 
valuable statistical year-books published by many nations and by a 
number of important cities. The student will find the statistical annuals 
of Australia and New Zealand especially interesting and instructive. 



INDEX 



Activity, desire for, as an economic 
motive, 104. 

Adams, H. C, on fiscal aspects of the 
tariff, 717. 

Agriculture, changes in, in England, 41, 
50; history of, in United States, 84; 
problems of, 5g6. 

Agricultural credit, 609. 

Agricultural stage, 37. 

Aldrich, N. W., plan for banking reform, 
306. 

Aldrich-Vreeland Act, 305. 

Altruism, as an economic force, 103. 

American Federation of Labor, 94, 444. 

American people, economic characteris- 
tics of, 63. 

Amortization of taxes, 706. 

Anarchism, 638. 

Andrew, A. P., on control of banking re- 
serves by Secretary of the Treasury, 

354- 
Annual product, defined, 517. 
Anti-trust laws, 235. 
Arbitration, in labor disputes, 95, 457. 
Aristotle's Politics, 741. 
Artificers, statute of, 43. 
Assumption of risk, legal doctrine of, 487. 
Austrian school, 752. 
Averages, 340. 

Balanced revenue system, 735. 

Balance of trade, 345 ; meaning of a 
"favorable balance," 356; in the com- 
merce of the United States, 357. 

Bank acceptances, 346 n. 

Bank credit, 286. 

Bank notes, 290, 291, 306, 309. 

Bank of England, control of gold reserves, 
302. 

Banking, functions of, 283. See Na- 
tional banking system. Federal reserve 
system. 

Bargaining, surplus in, 181. 

Basing-point, system, 570. 

Bastiat, Fr6d6ric, 750. 



Benefit principle, in taxation, 698. 

Bentham, Jeremy, 746. 

Bills of credit, colonial and revolution- 
ary, 272. 

Bimetallism, 260; in the United States, 
264; international, 263. 

Birth rate, in United States, 65. 

Blackstone, definition of monopoly, 190 n. 

Bland-Allison Act, 266. 

Blodgett, J. H., on wages of farm labor, 
607. 

Bonds, corporation, 220; government, 
as security for bank notes, 300. See 
Public debts. 

Boycotts, legahty of, 475. 

Brassage, 258. 

Brown, E. F., on factory inspection in 
the United States, 485. 

Budgets, French, old and modern con- 
trasted, 657 ; American, 662. 

Bullock, C. J., on foreign trade balances 
of the United States, 357. 

Business organization, forms of, 214.' 

Business taxes, 733. 

Business unit, in accounting, 213; in 
law, 214. See Large-scale production. 

Call loans, 289, 295. 

Canadian Industrial Disputes Act, 459. 

Canon law, economic ideas in, 743. 

Carey, H. C, 750, 751. 

Carver, T. N., on the effects of the ma- 
chine system upon the workers, 127. 

Capital, as a factor in production, 121; 
distinguished from capital value, no; 
distinguished from consumption goods, 
512; distinguished from land, 507 ; 
social and individual, in; free and 
speciaHzed, 506 ; investment in, 499, 
5x3; replacement of, 501; effects of 
varying degrees of durability of, 502; 
price of, how determined, 505 ; pro- 
ductivity of, relation to interest, 495 ; 
relation to advances of wages, 512 ; in 
business usage, 219. 



761 



7t)2 



INDEX 



Capitalization, corporation, 2ig, 221, 
225 ; of rent, 418. 

Central banks, 304, 307. 

Central reserve system, 2g2. 

Charters, corporation, 217. 

Child labor laws, 56, 476. 

Christianity, influence on economic 
thought, 742. 

Christian sociaUsm, 630. 

Cities, growth of, in United States, 66. 

Class price, 204. 

Classical school, 746. 

Clayton Anti-trust Act, 241 ; in relation 
to labor organizations, 473. 

Clearing houses, 283. 

Clearing-house loan certificates, 284 n., 
305- 

Closed-shop policy, 448. 

Coinage, 24.Q; of standard money, 255; 
limited, 259. 

Coke, definition of monopoly, 190 n. 

Collective bargaining, 442, 446. 

Colonial policy, British, 80. 

Combination Act, British, 58. 

Combinations, industrial, 230 ; causes 
of, 232 ; public policy toward, 243 ; in 
other countries, 245; railway, 561. 

Commerce Court, 574. 

Commons, J. R. on relation of monopo- 
lies to the distribution of wealth, 550. 

Comparative costs, law of, 362 ; relation 
to doctrine of free trade, 375. 

Competition, described, 28; failure of, 
under certain conditions, 198; relation 
to maximum satisfaction of wants, 538. 

Competitive investment, 513- 

Commission merchants, 620. 

Communism, 631. 

Compulsory arbitration, 459. 

Comte, Auguste, 749. 

Concentration in industry, 88. See 
Large-scale production. 

Concentration of wealth, distinguished 
from large-scale production, 542 ; 
methods of measuring, 543 ; possibility 
of lessening, 55 r; suggested remedies, 

SS4- 

Conspiracy, legal status of, 472. 

Constant expenses, relation to normal 
price, 171. 

Constitutional limitations, to govern-" 
ment regulation of industry, 96 ; to 
railway regulation, 184, 573 ; to taxa- 
tion, 710. 

Consumers' surplus, 161. 



Consumption, defined, 132 ; statistics of, 
144 ; harmful, 144. 

Consumption goods, no. 

Contract, as an economic institution, 25 ; 
in relation to distribution of wealth, 
386. 

Contributory negligence legal doctrine of, 
487. 

Cooperation, as an economic institution, 
30 ; different forms of, 464 ; in market- 
ing, 465, 619; cooperative credit, 46s, 
613. 

Copyrights, 23 ; as a source of monopoly,' 
195- 

Corporations, as business units, 216; 
charters of, 217; advantages of, 228; 
growth of, 87; management of, 226; 
social aspects of, 228; lack of uni- 
formity in state laws, 218 ; federal con- 
trol needed, 245; taxation of, 731. 
See Capitalization, Overcapitalization, 
Trusts. 

Corpus juris civilis, 742. 

Cost of living, statistics of, 341', 548. 

Cost of production, 148. See Expenses 
of production. 

Cotton industry, growth of in early 
nineteenth century, 82. 

Credit, functions of, 2S2 ; personal credit, 
285; bank credit, 286; credit trans- 
actions, 282. 

Crises, analyzed, 2>2ii ; crisis of 1873, 276 ; 
1892, 267; 1907, 305. 

Custom, as an economic institution, 31. 

Customs duties, fiscal aspects of, 713. 
See Protection. 

Decreasing expenses, relation to normal 
price, 171. 

Deferred payments, standard of, 337. 

Demand, nature of, 156; demand curve, 
158. 

Deposits, bank, 283 ; how safeguarded, 
287. 

Dewing, A. S., on inefficiency of indus- 
trial combinations, 235. 

Diminishing productivity, law of, 388; 
of labor, 390 ; of capital and land, 392 ; 
actual operation of, 395 ; social aspects 
of, 404. See Marginal productivity. 
-Diminishing returns, law of, 419. 

Diminishing utility, law of, 133. 

Direct appropriation, stage of, 34. 

Direct taxes, 702, 710; use of, by federal 
government, 712. 



INDEX 



763 



Discount, bank, 287 ».; rates, relation of 
to price of foreign exchange and to 
international gold movements, 302, 
311, 346, 349, SSI- 
Distribution of wealth, as a general eco- 
nomic problem, 384; among persons, 
_542- 

Distributive cooperation, 464. 

Distributive justice, 627. 

Division of labor, ig; effects upon the 
worker, 127; relation to condition of 
decreasing expenses, 172. 

Documentary bills, 346. 

Domestic system, 40. 

Economics, defined, 4; distinguished 

from economy, 13 ; concepts of, 103 ; 

relation to other sciences, 1 1 ; laws of, 

7- 
Economic classes, 21. 
Economic goods, defined, 106. 
Economic society, evolution of, S3- 
Economic stages, 33 ; table of, 45 ; in 

American history, 61. 
Economic thought, history of, 74 1 ; 

present condition of, 752. 
Effort, necessary to production, 106. 
Elasticity of demand, isg. 
Employers' associations, 95, 454. 
Employers' liability, law of, 56, 486, 588. 
Endowments, 584. 

Engel, Ernst, laws of expenditure, 145. 
Entrepreneur, functions of, 123; as risk 

taker, S37- 
Entrepreneur's wage, 168, 526. 
Equation of exchange, 321. 
Esteem, desire for, as an economic motive, 

104. 
Ethics and politics, relation to economics, 

IS- 
Exchange, 19. See Division of labor. 
Exchange value. See Value. 
Expenses of production, 148 ; relation to 

price, 167, 186. 
Express trusts, 228 w. 

Fabian socialism, 629. 

Factors of production, 119; ultimate, 

522. 
Factory acts, in United States, 484. 
Factory system, in England, 51; in 

United States, 82. 
Faculty principle, in taxation, 698. 
Fair competition, 29. 
Farming, intensive and extensive, 600. 



Farms, size of, in United States, • 596 ; 
ownership and tenancy, 603 ; indebted- 
ness, 609. 

Favoritism, as a source of monopoly 
power, 191, 197. 

Federal Farm Loan Board, 613. 

Federal land banks, 614. 

Federal Reserve Board, 307. 

Federal reserve system, organization, 
307; reserves, 308; rediscounting, 
308; note issue, 310; other functions, 
310; resources and liabihties of, in 
1916, 313- 

Federal taxation, 710. 

Federal Trade ComiTiission, 142. 

Fees, as source of pubHc revenue, 690. 

Fellow-servant doctrine, 487. 

Fiat money, 278. 

Final consumption, 132. 

Finance bills, 350. 

Fiscal monopolies, 197, 682. 

Fisher, Irving, proposal for a "stabilized 
dollar," 342 ; Statistical verification of 
the equation of Exchange, 324 n. 

Fisk, G. M., on early restrictions on in- 
ternational trade, 358. 

Fixed and variable expenses, 174; rela- 
tion to normal price, 177 ; in railway 
operation, 569. 

Foreign exchange, 345. 

Forest lands, 674. 

Form utility, 116. 

Fourteenth Amendment, 184, S73- 

Freedom, economic, 26; relation to dis- 
tribution, 386 ; of contract, 472. 

Free goods, 105, 401. 

Free silver. See Bimetallism. 

Free trade, advantages of, 374. 

Future products, alleged present con- 
sumption of, 142. 

Future wants, 140. 

General changes in prices, relation to 
quantity of money, 319; mechanism 
of, 325 ; effects of industrial uses of 
gold upon, 327 ; effects of expenses of 
gold production upon, 328; economic 
effects of, 331 ; relation to international 
gold movements, 351; index numbers 
of, 337- 

General property tax, 726; defects of, 
727 ; reform of, 729. 

General welfare monopolies, 195. 

George, Henry. See Single tax. 

Gilds, 39. 



764 



INDEX 



Godin Jamilistere, 466. 

Godwin, William, 748. 

Gold, as monetary standard, 255, 269; 
relation of industrial uses of, to prices, 
327 ; relation of expenses of production 
to prices, 328; increase in production 
of, 329; international movement of, 
3SO. 

Gold-exchange standard, 269. 

Gold points, 348. 

Goldenweiser, E. A., on farmers' incomes, 
607. 

Goods, defined, 105. 

Good-will, in relation to profits, 535. 

Government enterprise, extension of in 
England in nineteenth century, 58. 

Government ownership, of railways, 571 ; 
of other industries, 682. 

Government paper money, 271. 

Greeks, economic ideas of, 741. 

Greenbacks, 273 ; economic effects of, 

ays- 
Greenback party, 278. 

Gresham's lav/, 261. 

Group rates, 570. 

Hadley, A. T., on improvident poor re- 
lief, SS2. 

Hamilton, Alexander, Report on the 
establishment of a mint, 264 n. 

Handicraft stage, 39. 

Hedging, 532 n., 624. 

Hildebrand, Bruno, classification of 
economic stages, 44. — „ 

Historical school, 749. 

Holding company, 231. ^\ 

Hours of labor, statistics of, 548. 

Hume, David, on Elizabethan monop- 
olies, 206. 

Hunter, Robert, on distinction between 
poverty and pauperism, 553. 

Immigration, to United States, 68 ; 

changing character of, 70; restriction 

of, 72. 
Imputed interest, 495. 
Inclosures, 41, 50. 
Incomes, estimates of distribution of in 

United States, 544; in Prussia, 546. 
Income taxes, 720. 
Increasing expenses, relation to normal 

price, 170. 
Indentured servants, in United States, 66. 
Independent treasury system, 297, 353. 
Index numbers, 337. 



India, monetary system of, 270 n. 

Indirect taxes, 702, 713. 

Individual entrepreneur, as business 
unit, 214. 

Individual wealth, contrasted with social 
wealth, 109. 

Industrial combinations, 230; causes of, 
233; legal status, 235; public policy 
toward, 243; in other countries, 245. 

Industrial democracy, 463. 

Industrial insurance, 585. 

Industrial Revolution, 47 ; evils of transi- 
tional period, 52 ; in America, 81. 

Inelastic currency, 300. 

Inelastic reserves, 301. 

Inheritance, 24; effect on distribution, 
386; taxation of, 723. 

Instincts and habits, in economic activity, 
105. 

Insurance, nature of, 577 ; development 
of, 578; forms of organization, 580. 
See Life insurance, Social insurance. 

Integration of industry, 88. 

Interest, formerly condemned, 493, 743 ; 
inadequate explanations of, 494 ; how 
possible, 495 ; why necessary, 496 ; 
normal interest, 511 ; rate, determined 
by supply and demand of investment 
funds, 521; on farm mortgage loans, 
610. See Discount. 

Internal improvements, state activity in, 
93, 217. 

Internal revenues, 717. 

International gold movements, 302, 311, 
/ 348, 350. See Balance of trade. 

International trade, restrictions of, in 
former times, 358 ; modern restrictions, 
360; advantages of, 361. 

Interstate Commerce Act, 573. 

Interstate Commerce Commission, 574. 

Inventions, eighteenth century, 49. 

Investment, in capital goods, 499, 513; 
shifting of, 502 ; affected by durability 
of capital goods, 502 ; competitive, 
513 ; cumulative nature of, 518. 

Investment funds, sources of, 523. 

Jaures, Jean, on policies of socialism, 630. 
Jenks, J. W., investigation of monopoly 

prices, 206. 
Jevons, W. S., on necessary subdivision 

of economic science, 753- 
Joint expenses, relation to normal price, 

179. 
Joint-stock companies, 216 w. 



INDEX 



765 



Kartells, 246. 

Kelley, Florence, on child labor laws, 

478 ; on minimum wage laws, 480. 
Kemmerer, E. W., statistical verification 

of the equation of exchange, 324 n. 
King, W. I., estimates of distribution of 

incomes in the United States, 54s, 

64s n. 
Knights of Labor, 04, 444. 
Kropotkin, P., on anarchism, 630. 

Labor, as a factor in production, 120. 
See Wages. 

Labor legislation, 471 ; general principles 
of, 48S ; in England, 56. 

Labor organizations, development of, in 
United States, 93 ; in England, 57 ; 
/ types of, 444; economic justification, 
445 ; as monopolies, 446 ; methods and 
policies, 447 ; educational and fraternal 
activities, 451; relation to industrial 
democracy, 468; legal status of, 58, 
237, 472. 

Labor-saving machinery, effect on wages, 
430. 

Laissez-faire, 54, 745-748. 

Land, as a factor in production, 119; 
services of, 408 ; distinguished from 
capital, 507. See Rent, Public do- 
main. 

Land nationalization. See Single tax. 

Large-scale production, economies of, 
relation to normal price, 173; not a 
source of monopoly power, 200. 

Lexis, Wilhebn, on coinage regulations, 

257- 

License taxes, 733. 

Life insurance, 581 ; premium plans, 582 ; 
reserve and surplus, 583 ; industrial, 
585 ; State, 585 ; State regulation of, 
586; for workingmen, S93- 

Life tables, 589. 

Limitation of output, by labor organiza- 
tions, 449; by monopolies, 201. 

List, Friedrich, 751. 

Localization of industry, 128. 

Luxury, 143. 

Malthus, T. R., 746 ; law of population, 

434, 746. 
Manor, English, 37. 
Manufactures, growth of, in the United 

States, 86. 
Margin of consumption, 141. 
Margin of cultivation. See Rent. 



Marginal productivity, 390; of labor 
390 ; of capital and land, 392 ; general 
principles of, 396 ; relation to prices of 
production goods, 398 ; lack of ethical 
significance, 403 ; relation to profits, 
S3 2. See Diminishing productivity. 

Marginal utility, defined, 135; illus- 
trated, 136. 

Markets, defined, 154; expansion of , 52. 

Marketing of farm products, 618. 

Marx, Karl, labor theory of value, 186; 
other doctrines, 629. 

Marxian socialism, 629. 

Medium of exchange and measure of 
value, 252. 

Mercantile system, 42, 359, 744; in 
America, 79. 

Mill, J. S., on equilibrium of supply and 
demand, 165. 

Minimum wage laws, 459, 480. 

Mint ratio, 260. 

Mitchell, W. C, statistics of prices and 
wages in the greenback period, 277. 

Monetary standard, 255. See Bimetal- 
lism. 

Money, defined, 250, 251; metallic, 249; 
varieties used in the United States, 
254; government paper money, 271; 
value of, 317. 

Money income, 387 ; flow of, 515. 

Money market, defined, 289; controlling 
conditions, 289; New York, 293; 
London, 347. 

Monopolies, Statute of, 191 ; Case of, 
191 ; classification of, 193 ; labor 
organizations as, 446. 

Monopoly, 30 ; defined, 190 ; contrasted 
with competition, 189; distinguished 
from differential advantage and from 
large-scale business, 193 ; relation to 
distribution of wealth, 207, 550; 
pubHc pohcy with respect to, 208. 

Monopoly price, 200 ; relation of demand 
to, 203 ; effect of taxation, 202 ; 
usually high, 205. 

Mortgage land banks, 612. ^ 

Motives in economic activity, 103, 
538. 

Mun, Thomas, 744. 

Munn vs. Illinois, 573. 

National banking system, 291 ; reserves, 
292, 308 ; notes, 292, 300, 309 ; defects 
of, 29s ; steps toward reform of, 304. 
See Federal reserve system. 



766 



INDEX 



National income, defined, 114. 
National Monetary Commission, 306, 

316. 
National wealth, statistics of, 112. 
Natural laws, 8. 
Natural monopolies, 197. 
Natural resources, of United States, 74. 
Navigation Acts, So. 
Negro problem, in United States, 66. 
New York money market, 293 ; relation 

to speculation, 295. 
New Zealand, compulsory arbitration in, 

459- 
Non-reproducible goods, price of, 182. 
Normal interest, 511. 
Normal price, 169. 

Occupational distribution of the Ameri- 
can people, 86. 

Old age pensions, 592. 

Open-market operations of federal reserve 
banks, 311. 

Opportunity cost, 148. 

Optimists, economic, 749. 

Overcapitalization, 221. 

Owen, Robert, 628. 

Paper money, 271. 

Par of exchange, 348. 

Partnerships, 215. 

Pastoral stage, 36. 

Patents, 23; as a source of monopoly, 

195- 
Personal distribution of wealth, 542. 
Personal property tax, 726. . 
Personal qualities as goods, 107. 
Philippines, monetary system of, 270 n. 
Physiocrats, 745. 
Place utility, 116. 
Plato's Republic, 741. 
Pollock case, 711. 
Poll taxes, 734. 
Pools, 231, 56r. 
Population, growth of in nineteenth 

century, 435 ; growth of, in United 

States, 64. See Malthus. 
Poverty, causes of, 549. 
Power, desire for, as an economic motive, 

104. 
Present economic system, characteristics 

of, 17. 
Price, defined, 152; fixed by equilibrium 
• of supply and demand, 164; normal 

price, 169; monopoly price, 200; of 

production goods, 398, 418, 505; of 



pubhc services, 685. See General 
Changes in prices. 

Primitive man, economy of, 35. 

Private banks, 314. 

Private property, as an economic insti- 
tution, 21 ; relation to distribution, 386. 

Probabilities, law of, 578. 

Producers' cooperation, 466. 

Producers' surplus, 165. 

Production, defined 117; relation to 
sacrifice, 146. 

Production goods, no, 40 r ; prices of, 
185, 398, 418, 505. 

Production of gold, increase in, 329. 

Productive consumption, 132. 

Productive organization of the American 
people, 129. 

Productivity, meaning of, 400, 497. 

Profits, 525; pure profits distinguished 
from entrepreneur's wage, 526; non- 
existent under certain conditions, 527; 
two sources of, 528; relation to prin- 
ciple of diminishing productivity, 532; 
for the industry and for the establish- 
ment, 533; relation to good-will, 535; 
relation to risk, 540 ; often associated 
with other forms of income, 538; 
relation to defense of the competitive 
system, 538; of monopoly, 201. 

Profit sharing, 461. 

Protection, nationalistic argument for, 
368; infant industry argument, 369, 
376; military argument, 370; home 
market argument, 371, 376; as a de- 
fense against dumping, 371 ; wages ar- 
gument, 373, 377 ; "equalizing costs of 
production," 373 ; fiscal aspects of, 
378, 713; Ethical aspects of, 379; 
relation to monopoly, 194, 380. 

Public authority, relation of, to prices, 
183. 

Public consumption monopolies, 197, 682. 

Public debts, increase of, 666 ; relation to 
public works, 668 ; relation to taxes, 
668 ; wise use of, 610. 

Public domain, as a source of revenue, 
671. See PubHc lands. 

Public expenditures, growth of, 644 ; 
contrasted with private expenditures, 
646 ; relation to total social income, 
648; extravagance, economy, and 
parsimony in, distinguished, 652; 
changing objects of, 654; regularity 
of, 659 ; classification of, 660 ; statis- 
tics of, in United States, 662. 



INDEX 



767 



Public finance, 643. 

Public lands of the United States, eco- 
nomic importance of, 75 ; development 
of government's policy, 76, 673 ; 
forest lands, 674; mineral lands, 675. 

Public monopolies, 194. 

Public receipts from loans, 661 ; from 
public domain, 671; from public 
industries, 682 ; from fees, 690 ; 
from special assessments, 692 ; from 
taxes, 694; statistics of, for the 
United States, 695. 

Quality of goods, government regulation 

of in England, 55. 
Quantity theory of prices, 324. 
Quasi-rent, 509. 
Quesnay, 745. 

Race suicide, 65. 

Railway rates, movement of, 563 ; 
general level of, 565; relative, 567; 
distance, as a factor in, 570. 

Railways, history of, in United States, 
91; economic importance of, 558; 
competition of, 91, 560; pooling and 
consolidation, 560 ; valuation of, 566 ; 
expenses of, apportionment, 568 ; 
government ownership, 571; govern- 
ment regulation, 573 ; affected by 
Sherman Anti-trust Act, 237. 

Raymond, Daniel, 751. 

Rediscounting, 308. 

Religion as an economic factor^ 104. 

Rent, 407 ; under uniformly intensive 
use of land, 410; under actual condi- 
tions, 413 ; relation of different uses 
of land to, 416; the specific product 
of land, 394, 416; capitalization of, 
418; relation to social progress, 419. 

Replacement fund, 501. 

Reserve, insurance, 583. 

Reserves, bank, 288, 292, 301, 308. 

Retail prices, 182. 

Ricardo, David, 746. 

Risk, 107; relation to profits, 536; re- 
lation to insurance, 577. 

Romans, economic ideas of, 742. 

Roosevelt, Theodore, on mineral land 
policy, 676. 

Rowntree, B. S., on causes of "primary" 
poverty, 551. 

Rubinow, I. M., on recent changes in 
real wages, S47- 

Rural credit, 609. 



Saving, and the formation of capital, 122, 
4Q7, 502, 522. 

Savings banks, 314. 

Scarcity, a necessary condition of value, 
106, 156, 401; of raw materials, a 
source of monopoly power, 197. 

Second Bank of the United States, 
304 n. 

Secrecy, as a source of monopoly power, 
199. 

Sectionalism, in American history, 62. 

Seigniorage, 255 ; on limited coinage, 
259- 

Self-maintenance, as an economic motive, 
103. 

Serra, mercantilistic writings of, 744. 

Services, as economic goods, 106. 

Shaw, L. M., control of gold reserves by, 
when Secretary of the Treasury, 353. 

Shays's rebellion, 62. 

Sherman Anti-trust Act, 236. 

Sherman Silver-purchase Act, 266. 

Shifting of taxes, on monopolies, 202 ; 
general theory of, 703 ; of import 
duties, 714. 

Sickness insurance, 591. 

Single tax, 425, 679, 706 ; imp6t unique, 
IAS- 

Size of business unit, increase in, 88 ; 
statistics of, 89. See Large-scale pro- 
duction. 

Slater, Samuel, 82. 

Slavery, 37 ; in the United States, 66. 

Small Holdings Act, 602. 

Smith, Adam, 48, 53, 745 ; on wages in 
different employments, 441. 

Smith, Constance, on operation of British 
Trade Boards Act, 483. 

Social dividend, 517. 

Social insurance, 57 ; defined, 587 ; 
against industrial accidents, 487, 588; 
against sickness, 591 ; against old age, 
592; against unemployment, 592; 
objections to, S93- 

Social laws, nature of, 11. 

Social monopolies, 195. 

Social wealth, contrasted with individual 
wealth, 109. 

Socialism, defined, 627 ; varieties of, 628 ; 
an extension of existing institutions, 
632; strength of, 632; weakness of, 
634; growth of, 636; position in eco- 
nomic thought, 748. 

Sociology, 13, 748. 
I Special assessments, 692. 



768 



INDEX 



Special privilege monopolies, ig7. 

Specialization. See Division of labor. 

Specie payments, suspension of, 273 ; 
resumption of, 275. 

Specific productivity. See Marginal pro- 
ductivity. 

Speculation, relation to New York money 
market, 295 ; as a source of profits, 
534; in agricultural produce, 622. 

Standard of deferred payments, 336. 

Standard of life, 438. 

Standard Oil Co. Case, 230. 

Standard Oil Trust, 230. 

State activity, present scope of, 17. 

State banks, before Civil War, 290 ; pres- 
ent position, 313. 

State insurance, 585. 

State regulation of industry, develop- 
ment of, in United States, 96. See 
Anti-trust laws. Labor legislation, 
Railways. 

State socialism, 631. 

State and local taxation, 726. 

Steuart, Sir James, 744. 

Stock, corporation, 220. 

Strikes, 452. 

Subjective value, 137; of a stock, 138; 
relation to exchange value, 155. 

Subsistence theory of wages, 437. 

Supply, nature of, 162; relation to 
normal price, 167, 170. 

Supply curve, short-period, 163 ; long- 
period, 174. 

Supply and demand, 156. 

Supply and demand curves, 164. 

Surplus, bank, 287 n. ; insurance, 583 ; 
consumers', 161; producers', 165; of 
bargaining, 181, 442. 

Surplus value, doctrine of, 629. 

Syndicalism, 63 1 . 

Tabular standard, 342. 

Tariff, and sectionalism, 63 ; as source 
of revenue, 713. See Protection. 

Taxation, 694 ; justice in, 696 ; progres- 
sive, 699 ; direct and indirect, 702 ; 
shifting of, 202, 703, 714; federal, 710; 
state and local, 726. 

Taylor, H. C, on farm tenancy in 
England, 618. 

Tenancy, farm, increase of, 603 ; com- 
pared with encumbered ownership, 615. 

Time utility, 116. 

Trade arbitration, 457. 

Trademarks, 23, 196. 



Trade unions. See Labor organizations. 
Transactions, taxes on, 719. 
Transportation, 557. See Railways. 
Trust companies, 314. 
Trusts, 230. See Combinations. 
Turgot, 745. 

Unearned increment, 422. , 

Unemployment insurance, 592. 
Unfair competition, 29, 239, 243. 
United States, economic development of, 

61. 
United States Bank, 304 n. 
United States Steel Corporation, 88. 
Urban lands, rent of, 426. 
Urdahl, T. K., on fee system, 692. 
Use price, 205. 
Usury, 493, 523, 743. 
UtiHty, defined, 105. 
Utopian socialism, 628. 

Valuation, of public-service properties, 

184, 209 »., 566. 
Value, exchange, 152 ; subjective, 137, 

155; production of, 118. See Price. 
Values of money, 317. See General 

changes in prices. 
Variable expenses, relation to normal 

prices, 177. 
Vested interests, 25. 
Victoria, wage boards in, 459, 480. 
Voluntary arbitration, 458. 

Wages, as price of labor, 427; fixed by 
demand and supply, 428; afi"ected by 
structure of the population, 432 ; 
aSected by growth of population, 434 ; 
subsistance theory of, 437 ; relation 
of standard of life to, 438 ; in different 
occupations, 439 ; statistics of, in 
United States, 341, 547 ; agricultural 
wages, 606; statistics of agricultural 
wages, 608; in greenback period, 277. 

Wages of management. See Entre- 
preneur's wage. 

Wage boards, 95, 459, 480. 

Wagner, Adolph, statistics of incomes 
in Prussia, 546 ; on public expendi- 
tures, 650. 

Waiting, 106; an ultimate agent of pro- 
duction, 522; relation to interest rate 
499.521. 

Wants, nature of, 133. 

Wealth, distinguished from income, 108. 



INDEX 



769 



Wealth of Nations. See Smith, Adam. 
Weld, L. D. H., on state regulation of 

commission merchants, 621. 
Wholesale prices, statistics of, 341, 548. 
Willcox, W. F., on growth of population, 

436. 



Willoughby, W. F., on philosophy of 
labor legislation, 4go. 

Women, legal regulation of labor of, 470. 

Workmen's compensation laws, British, 
57 ; in United States, 488, 589 ; stand- 
ards for, sgo. 



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